ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Illinois is representative of a common inquiry related to an employee stock ownership plan (ESOP). The advisor asked: “One of my clients with an ESOP asked about a true up provision in his plan. What is an ESOP true up provision?”
Highlights of Discussion
I believe what your client is referred to is a “rebalancing” provision in the ESOP. Rebalancing is the periodic mandatory transfer of employer securities among participant accounts, resulting in all participants having the same proportion of employer stock to other investments as in the ESOP trust as a whole (see this 2010 IRS Memorandum for more details). For example, if the ESOP was invested 70 percent in employer stock and 30 percent in other investments, after rebalancing, each participant's ESOP account would be invested 70 percent in stock and 30 percent in other investments.
Rebalancing usually happens at the end of the plan year and does not affect the face value of an ESOP participant’s account balance. According to the IRS’s, Listing of Required Modifications for ESOPs, “rebalancing, which treats all participant accounts the same, will not raise issues of current or effective availability and is generally acceptable.” Rebalancing is different than “reshuffling,” which will be covered in a future Case of the Week.
For an ESOP to be able to perform rebalancing it:
- Must hold cash; and
- The plan document must include an annual rebalancing provision.
An example of where rebalancing may come into play could be in a mature ESOP that has allocated all of its shares to its employees and begun contributing cash into the accounts of new employees. Without rebalancing, the new ESOP participants would not be shareholders in the ESOP.
Conclusion
Rebalancing is the mandatory transfer of employer securities into and out of the accounts of ESOP participants, usually on an annual basis, designed to result in all participant accounts having the same proportion of employer securities. In order to rebalance, the plan document must have specific language permitting rebalancing.
Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.
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