My client maintains an ESOP that requires distributions to be made available to the participant the 6th plan year following termination of employment (with exception for retirement, death, disability). Client wants to amend the plan to say that distributions will be available NO LATER THAN the 6th plan year following termination of employment. The idea is to give the employer discretion as to when to offer a distribution to each participant. With the amendment, the employer could offer a distribution in Year 1 if it felt the stock price was rising, or wait until year 5 if it felt the price was falling. This would only be a right to a distribution as, of course, absent retirement or death, we could not force a distribution. This is an S-corp. ESOP with cash only distributions. The participant's account is not converted to cash until an election is made to take a distribution. ASSUMING this discretion was exercised in a way that does not discriminate in favor of HCEs, can this be done? I assume it may be a benefit,right or feature that would need to be tested separately.


This "smells" bad to me for a number of reasons. I can foresee participants being angry that they were not given the same offers as other participants, etc. I suppose there could be fiduciary issues as well (though it is up to the participant on whether to take the distribution offer). I think this is a bad idea; my client disagrees and wants to do this unless there is a legal impediment to doing so. This could also be a more general question in any qualified plan: can the employer exercise discretion as to the timing of a distribution? I have seen plans that say distributions will be made within one year, but have not seen anything longer than one year and not in the context of an ESOP.

Any thoughts or comments would be greatly appreciated.

Hi beth ---

As a general rule, IRC section 411(d)(6) and ERISA section 204(g)(2) preclude having employer discretion with respect to benefit distributions. However, section 411(d)(6)© and section 204(g)(3) permit the "modification" of ESOP distribution options in a nondiscriminatory manner, subject to the requirements of IRC section 409(o).

For purposes of the IRC, nondiscrimination would be subject to a section 401(a)(4) standard. Under ERISA, nondiscrimination would be evaluated under a section 404(a)(1) fiduciary standard whereby participants in like circumstances must be treated in a like manner.

As a general rule, the IRS has interpreted this ESOP exception to the "anti-cutback" rule to allow either for formal amendments to the plan document provisions applicable to benefit distributions or for the adoption of a separate written benefit distribution "policy" which may be modified from time to time. In either case, it is necessary to communicate the applicable benefit distribution rules (and any changes thereto) to the ESOP participants.

Beth....you seem to be increasingly involved in ESOP issues. I recommend that you consider joining The ESOP Association, www.esopassociation.org , and the National Center for Employee Ownership, www.nceo.org .

RLL - thanks for taking time to comment - that is very helpful.

It seems to me that there is not a cutback issue, even absent the special rules for ESOPs, since the amendment would allow, in the employer's discretion, distributions at an earlier date than the plan allowed prior to the amendment and never at a later date.

One potential problem once the amendment is adopted - absent the ESOP exception, it would be a cutback to ever go back to the original distribution provisions.