Distribution planning is one of the most important components of the planning process. Even if you had a detailed plan in place when you established your plan, chances are that things have changed. You should perform a distribution analysis annually. Here are some things to consider:

• Do you have any participants who are eligible to diversify a portion of their account balances? The Code provides that participants age 55 and older with 10 years of participation (as defined by the plan or other administrative document) are eligible to diversify a portion of their company stock. They are eligible to diversify 25% of the shares that they ever owned (assuming they still own them) in the first five years of eligibility and 50% in the sixth and final year. Many plans provide more liberal diversification provisions, so make sure to check the plan document. Remember that distributions above the statutory diversification amounts are generally considered in-service withdrawals and not diversification distributions. It is important that you have identified which participants are eligible for diversification and when. Here are some issues you will have to deal with in making the diversification determination and providing the participants with the appropriate disclosures:
  
  
  • How are you going to process diversification payments? As diversification becomes an issue for your plan, you are going to need to determine how you are going to process diversification payments. You can process them in the following ways: Distribute in cash, distribute in shares (some experts advise that distributing shares is not a legitimate option), provide alternate investments in the plan, or transfer to another plan (such as a 401(k) plan) that has sufficient alternate investments. Many plan documents provide for all options, so you should make sure you have clearly documented how you will process diversification.
    
    
  • How does the plan define years of participation? Most plan documents do not define how years of participation are calculated, so this is another item that needs to be defined and documented. Many plans count all years in which a participant is in the plan, either including or excluding the years after termination. Other definitions include counting only the years that a participant has received a contribution.
    
    
  • Are you providing eligible participants with the appropriate disclosures in a timely manner? A diversification notice informing the participants eligible for diversification of their rights must be provided to participants no later than 90 days after the end of the plan year. If the allocation is final, you can send a final diversification disclosure to the participant (that will include the final amounts eligible to be diversified), and you will have satisfied the requirements. If the allocation is not completed, then you must send a preliminary disclosure (which does not need to include the amount eligible to diversify) no later than 90 days after the end of the plan year and a final diversification disclosure no later than 180 days after the end of the plan year. In some cases, the final allocation balances are still not known 180 days after the end of the plan year. While there is no formal guidance, I am not aware of any plans that have experienced any problems when they have sent the final diversification disclosures as soon as administratively feasible after receiving the final amounts eligible to diversify. Both disclosures should solicit an election on whether or not they are interested in taking a diversification distribution. You should collect a response from all participants to ensure that you have additional documentation to further demonstrate compliance. The preliminary election should be considered nonbinding, and the final election accompanied with a distribution form would instruct the plan to process a diversification payment.
    
    
• Is our plan impacted by the new diversification requirements added under the Pension Protection Act (PPA)? IRC Section 401(a)(35) was added by the Pension Protection Act of 2006 (PPA) (Public Law 109–280—Aug. 17, 2006). The rules apply to plans holding "publicly traded employer securities" and will therefore not apply to most closely held ESOPs. In our Analysis of the IRC Section 401(a)(35) Proposed Regulations we discussed how the definition of "publicly traded" impacts many ESOP definitions which could create problems for thinly traded companies.
  
  Transition guidance was provided in IRS Notice 2006-107, 2006-51 I.R.B. 1114 - Diversification Requirements for Qualified Defined Contribution Plans Holding Publicly Traded Employer Securities. The transition guidance was extended in IRS Notice 2008-7 - Extension of Transitional Relief for Diversification Requirements for Certain Defined Contribution Plans. Proposed Treasury Regulation - REG–136701–07 - Diversification Requirements for Certain Defined Contribution Plans is effective for plan years beginning on or after January 1, 2009. For 2008, plans may rely on IRS Notice 2006-107 or the proposed regulations.
  

The ESOP Planning process includes planning for both the current year ESOP administration process as well as the various events that take place over the life of an ESOP. This article is one in a series of ESOP Planning 2008 articles authored by Aaron Juckett. Aaron Juckett is an ESOP consultant and the founder of ESOP Insourcing LLC, an ESOP administration and consulting firm dedicated to providing ESOP companies with a first-class ESOP experience. If you need assistance with the ESOP Planning process, please call Aaron at 800-837-3112 or email him at ajuckett@esopinsourcing.com.