It is a fairly common practice for ESOP plan documents to contain references to ESOP distributions “policies” that are separate from the plan document itself and that are administered, or modified or amended, by plan fiduciaries (committees, trustees or the company). Generally, the practice is intended to provide the flexibility to make changes to how or when benefits will be paid to participants without the need to amend the plan document.
But the practice raises a host of legal issues. In order to obtain the IRS’s views on the use of such policies, we recently submitted the following questions in connection with a determination letter application:
- Is an ESOP distributions policy considered part of the plan document for purposes of a determination letter request?
- If so, will the IRS be treating such ESOP distribution policies as only amendable by the same party that amends the plan document (e.g., the employer)?
- If it is a part of the plan document, is it subject to the prohibition on “discretionary availability” of an alternate form of distribution, per Treasury regulations section 1.411(d)-4 (e.g., the plan administrator cannot retain the right to simply tell the participants when lump sums or other forms of benefit will be available)?
The IRS responded to us as follows:
“Any reference to a distribution policy in the plan document effectively designates the policy as an appendix to the document. Accordingly, because any changes to the policy represent an amendment to existing plan provisions, such changes should be made in accordance with the plan’s amendment procedure.”
The IRS response is reasonable and in line with how we advise ESOP sponsors to document their ESOP programs. However, it raises issues for ESOP sponsors that use distribution policies outside their plan document. We will be covering some of those issues in upcoming articles.
- If your ESOP operates under a distribution policy and you have not submitted it (or prior versions of it) with your plan document, will it pass muster with the IRS?
- Is it clear that the policy has been properly amended in the past; or if amendments are planned in the future?
- If it has been amended, have participants’ rights under ERISA been adequately protected, or have you left yourself open to potential claims?
Overall, a distribution policy should be treated with the same “reverence” as your plan document, whether it is from the company’s, the fiduciary’s or the participant’s perspective.
Learn More About ESOP Distributions
You can find more information at the National Center For Employee Ownership (NCEO).