Basic ESOP Distribution Rules 22 nd Annual Multi-State ESOP Conference Scranton, PA September 13-15, 2017 Jon A. Williams, QKA Blue Ridge ESOP Associates jwilliams@blueridgeesop.com Jane E. Rogers, QKA SES Advisors, Inc. jrogers@sesadvisors.com
Welcome to our Session! Introductions Today s Topics Distribution Requirements Distribution Policy Diversification Required Minimum Distributions Tax Withholding Requirements 2
Distributions Timing When the distribution will begin Method The manner in which the distribution will be paid (Lump sum or Installments) Form Cash, stock or a combination of both 3
Distributions: Timing General ERISA Requirements Internal Revenue Code (IRC) Section 401(a)(14) Distribution must commence no later than the 60 th day after the end of the plan year in which the latest of the following occurs: Earlier of age 65 or the plan s normal retirement age The 10 th anniversary of the date on which the participant began participating in the plan Termination of the participant s service 4
Distributions: Timing General ERISA Requirements IRC Section 401(a)(14) Rules governing early retirement benefits IRC Section 401(a)(9) Required minimum distributions Age 70 ½ Death 5
Distributions: Timing Accelerated ESOP Distribution Rules IRC Section 409(o) Apply to stock acquired by an ESOP after 1986 Retirement, death or disability End of the plan year following the plan year in which the event occurs Other termination End of the sixth plan year following the plan year in which employment terminates (unless reemployed) 6
Distributions: Timing Accelerated ESOP Distribution Rules Exception for leveraged ESOPs Distributions attributable to leveraged shares may be delayed until the plan year following the plan year in which the loan is repaid Applies only to C-Corporations? General ERISA Requirements may require an earlier payment 7
Distributions: Timing Notice and Consent Notice Requirements Notice provided between 30 and 180 days before the date of distribution 30 day waiting period can be waived Consent required For any distribution before the later of age 62 or the plan s normal retirement age, if vested balance exceeds $5,000 If vested balance exceeds $1,000 automatic rollover rules apply (unless plan limits cash-out amount to $1,000) 8
Distributions: Method Lump Sum distributions may be made in a single lump sum Installments Must occur in a substantially equal series of installments (not less frequently than annually) Over no more than 5 years (can be as many as 6 installments) Extension for large balances One additional year (but not more than 5 additional years) for each $210,000 or fraction thereof by which the participant s balance exceeds $1,050,000 (indexed) 9
Distributions: Form Cash Stock - a participant has a right to demand stock Exceptions apply Put Option 10
Requirement to Offer Stock Exceptions Charter or by law provision that restricts substantially all stock ownership to the ESOP or current employees. S Corporation May still distribute employer securities subject to the requirement that the shares be immediately resold to the employer or ESOP Banks Due to SEC regulation 11
Put Option on Stock Distributions Mandatory and immediate put option Put option allowed to be enforced once per year for two years in a 60 day window. If put option is not enforced during the first 60 day window, a second is offered the following year. If the option is not enforced in the second window, there is no further requirement for company to purchase shares. 12
ESOP Distribution Policies What is a Distribution Policy? An ESOP Distribution Policy is the specific rules developed by the Plan Sponsor and/or ESOP Committee that describe when and how distributions from the plan will occur. May be included within the plan document or in a separate distribution policy document. May be included within the plan document or in a separate distribution policy document IRS may request distribution policy document as part of a determination letter review process 13
ESOP Distribution Policies (continued) When an ESOP is adopted, the development of the distribution policy depends on: Repurchase liability and cash flow projections Lender/Third Party covenant requirements Leveraged vs. Non-Leveraged ESOP C vs. S Corporation Benefit amount/allocation issues Impact on company s financial statements Participant tax issues Legal Considerations (i.e. counsel s view of what should be included in the plan and what is appropriate for inclusion in a separate distribution policy) 14
ESOP Distribution Policies (continued) During the life of the ESOP, changes to the distribution policy or the plan may be appropriate or necessary if the initial distribution policy/plan design considerations have also changed Limitations on Right to Change Distribution Policies/Plan Document Distribution Provisions Fiduciary Responsibility of Trustee/ESOP Committee Code Section 411(d)(6) Anti-Cutback Rule The Anti-Cutback Rule prohibits a reduction in any accrued benefit by a plan amendment Accrued benefits include the timing, method and form of distributions However, there is an exception to the Anti-Cutback Rule which applies specifically to ESOPs 15
ESOP Distribution Policies (continued) ESOP Exception to the Anti-Cutback Rule Statute Code Section 411(d)(6)(C) provides there is not a violation of the anti-cutback rules when distribution options in an ESOP are modified in a non-discriminatory manner Regulations ESOPs can eliminate or retain discretion to eliminate: Lump sum or installment forms of distribution Stock distributions if employer becomes substantially employee owned or an S Corporation Cash distributions when employer s stock becomes publicly traded 16
ESOP Distribution Policies (continued) Recommended steps prior to modification of an ESOP Distribution Policy Update Repurchase Liability Study Review short and long-term cash flow projections S corporations Analyze impact on 409(p) testing Consider general non-discrimination and fiduciary requirements Review/analyze HR considerations Provide advance notice of changes to plan participants 17
ESOP Distribution Policy Example Goal #1 Commence distributions to pay terminated participants as soon as feasible in the year following termination Goal #2 Maintain current ESOP ownership Goal #3 Utilize allocated cash in the trust to fund distributions 18
ESOP Distribution Policy Example Timing: Death: distributable as soon as practicable following the participant s death Disability, Retirement and other Termination: distributable as soon as practicable following the end of the plan year in which the participant s employment ceased Form: Distribution of the vested participant account balances will be made in the form of cash unless a participant requests distribution in the form of Employer Securities Method: All distributions made in a lump sum 19
Traditional Diversification: Who is eligible for diversification? Age 55 Ten years of participation All plan years in which a participant has an account balance Only plan years in which a participant is eligible for contributions and forfeitures Be specific in plan document 20
Diversification: Timing of Election Participant must elect within 90 days following the end of the plan year ESOP trustee has 90 days after the election period to satisfy the diversification election Can diversify up to 50% over a six year period Can diversify up to 25% of shares ever allocated to the account (cumulative) over the first five years Can diversify an additional 25% of shares ever allocated to the account (cumulative) in the sixth election year 21
Diversification: Satisfying the Election Offer three or more alternative investment funds within the ESOP Offer a transfer to a sister qualified plan that offers three or more alternative investment funds Distribute cash equal to stock value Distribute stock (subject to the put option in a closely held company) 22
Diversification Example Susan attains age 55 during the 2012 plan year Her tenth year of participation is met in the 2015 plan year First election period January 1, 2016 March 31, 2016 23
Diversification Calculation Example Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Beginning shares 1,000.0 765.0 795.0 825.0 832.5 872.5 New shares allocated 20.0 30.0 30.0 30.0 40.0 50.0 Plus shares previously diversified 0.0 255.0 255.0 255.0 277.5 277.5 Subtotal 1,020.0 1,050.0 1,080.0 1,110.0 1,150.0 1,200.0 x25% (years 1-5) (50% year 6) 255.0 262.5 270.0 277.5 287.5 600.0 Less shares previously diversified 0.0 255.0 255.0 255.0 277.5 277.5 Shares eligible for diversification 255.0 7.5 15.0 22.5 10.0 322.5 Shares diversified 255.0 0.0 0.0 22.5 0.0 322.5 Balance after diversification 765.0 795.0 825.0 832.5 872.5 600.0 24
Required Minimum Distributions IRC 401(a)(9) establishes a mandatory date, known as the required beginning date, by which plan participants must begin receiving payment from the plan. Required Beginning Date (RBD) A participant who is not a 5% owner: The RBD is April 1 st of the calendar year following the calendar year in which (i) the participant attains age 70 ½, or (ii) the participant retires, whichever is later. A participant who is a 5% owner: The RBD is April 1 st following the calendar year in which the participant attains age 70 ½. 25
Required Minimum Distributions (continued) Calculation of the Required Minimum Distribution (RMD) Each calendar year following the RBD the participant is required to receive a minimum payment from the Plan as of each December 31 st. The RMD is calculated each calendar year based on the following equation: Value of Account Balance Life Expectancy Factor = Minimum Distribution Value of Account Balance is determined in the calendar year proceeding the distribution calendar year. Example, the 2017 RMD will be based on the participant s account balance as of December 31, 2016. The Life Expectancy Factor is determined using the Uniform Lifetime Table based on the participant s age in the distribution calendar year. If the participant s sole designated beneficiary is the spouse, and that spouse is more than 10 years younger than the participant, the Life Expectancy Factor is the joint life expectancy factor. 26
Required Minimum Distributions (continued) Age Applicable Divisor The "Uniform Lifetime Table" Age Applicable Divisor Age Applicable Divisor 70 27.4 86 14.1 102 5.5 71 26.5 87 13.4 103 5.2 72 25.6 88 12.7 104 4.9 73 24.7 89 12.0 105 4.5 74 23.8 90 11.4 106 4.2 75 22.9 91 10.8 107 3.9 76 22.0 92 10.2 108 3.7 77 21.2 93 9.6 109 3.4 78 20.3 94 9.1 110 3.1 79 19.5 95 8.6 111 2.9 80 18.7 96 8.1 112 2.6 81 17.9 97 7.6 113 2.4 82 17.1 98 7.1 114 2.1 83 16.3 99 6.7 115 + 1.9 84 15.5 100 6.3 85 14.8 101 5.9 27
Required Minimum Distributions (continued) Death of the Participant before RBD Where the participant dies before their RBD, the minimum distribution for the Participant s beneficiary is determined differently because minimum distributions were not required before the participant s death. Payment of the death benefit will either have to satisfy the five-year payment rule or the life expectancy rule. Death of the Participant after RBD Where the participant dies on or after their RBD, minimum distributions must be completed at least as rapidly as under the minimum distribution rules in effect. Determination of the remaining distributions depends on the designated beneficiary. The Life Expectancy Factor used to calculate the minimum distribution for calendar years after the participant s death depends on whether there is a designated beneficiary and, if so, whether the designated beneficiary is the participant s spouse. 28
Required Minimum Distributions (continued) RMDs are Not Eligible Rollover Distributions Because the RMD is not an eligible rollover distribution it is not subject to the mandatory 20% withholding. However, it is subject to 10% federal income tax withholding, unless the participant elects no federal withholding. 29
Tax Withholding Requirements All distributions from an ESOP are subject to income taxes, unless the distribution is rolled over to an IRA or other qualified plan. If the amount distributed is not rolled over to an eligible retirement plan, Federal regulations require that federal income tax be withheld at 20% of the taxable amount of the distribution. The participant may also be liable for an additional 10% early withdrawal penalty. However, the 10% penalty is waived if the distribution is made for one of the following reasons: 1) age 59 ½; 2) leave employment after age 55; 3) disability. 30
Tax Reporting Form 1099R, Distribution From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Used to report distributions paid from qualified retirement plans to the IRS and participants for the calendar year, regardless of plan year end. Participant copy of Form 1099R must be postmarked no later than January 31 st of the year following the distribution year (distributions paid in 2017 must be reported on 2017 Form 1099R and postmarked on or before January 31, 2018). Form 945, Annual Return of Withheld Taxes Used to report and reconcile all Federal tax withholdings from distributions paid during the calendar year. Due date is typically January 31 st of the calendar year following the calendar year of distributions. Note: States have different reporting requirements for taxes withheld so check with your advisor for state requirements. 31
Questions? Jon A. Williams, QKA Blue Ridge ESOP Associates www.blueridgeesop.com jwilliams@blueridgeesop.com Jane E. Rogers, QKA SES Advisors, Inc. www.sesadvisors.com jrogers@sesadvisors.com Thank you! 32