Question

Which of the following statements are correct regarding diversification requirements for participants in an ESOP?

a. Participants must be at lease 55 years old.

b. Participants must have been in the plan for more than 15 years.

c. Up to 50% of a participant’s ESOP balance can be diversified in the last year of the qualified election period.

d. Two of the above choices.

Answer 1

1) Legal Stance

The ESOP diversification rules under IRC Section 401(a)(28)(B) provide that a qualified participant must be given the opportunity to elect to diversify a portion of their ESOP account during their qualified election period.

A qualified participant is an employee who has completed at least 10 years of participation under the plan and has attained age 55. The latter is straightforward and the former is not clearly defined by the IRS.

The initial opportunity to elect must be offered within 90 days after the close of the plan year. The amount must be distributed within 180 days after the close of the plan year. The first requirement is easy to satisfy and the latter creates administrative issues for many ESOP companies.

The qualified election period is the 6-plan year period beginning after becoming a qualified participant.

A qualified participant is eligible to diversify 25% of their post-1986 stock balance for the first five years of their qualified election period and 50% of their post-1986 stock balance during their sixth and final year. The diversification calculation is a cumulative calculation, meaning that the stock balance consists of the number of eligible shares that have ever been allocated to a qualified participant's account less any shares previously distributed, transferred, or diversified. The resulting number may be rounded to the nearest whole integer.

Diversification can be satisfied by a distribution, a transfer to another qualified plan, or offering three or more investment options in the ESOP (certain requirements apply).

There is a $500 de minimis exception.

2) Option Scrutiny

1. Participants must be at least 55 years old. - Yes, Participant must be at least 55 years old.
2. Participants must have been in the plan for more than 15 years. - No, the participant must be in the plan for 10 years
3. Up to 50% of a participant’s ESOP balance can be diversified in the last year of the qualified election period. A qualified participant is eligible to diversify 25% of their post-1986 stock balance for the first five years of their qualified election period and 50% of their post-1986 stock balance during their sixth and final year. This option is not correct.
4. Two of the above choices. - Not correct remarks given above

3) Option Scrutiny - Correct option is A.