Coordinating an ESOP with Other Qualified Plans

Doug Johnson, ESOP Sr. Relationship Manager, Principal®

Having another qualified plan, such as a 401(k) Profit Sharing Plan, in conjunction with an ESOP can be very common and enhances the benefit offerings available to employees. This could be a 401(k) plan separate from the ESOP or combined into one plan. Regardless of the arrangement, there are many plan compliance and administrative issues which must be taken into consideration when sponsoring more than one type of plan.

Annual Additions Limit

The annual additions limit ($55,000 for 2018) takes into account all contributions made to all qualified plans by both the employee and the employer on an individual basis. This is a limit that is often easily violated when there are multiple plans involved. Using the example of a highly paid employee that is maximizing 401(k) deferral contributions ($18,500 for 2018) and receiving a 4% company match (based on the 2018 compensation limit of $275,000), the participant would already be at $29,500 of annual additions. This leaves $25,500 (or about a 9% contribution) for the ESOP allocation – which would include contributions, forfeitures, and ESOP loan payments (note that this limit does not include dividends or S-Corp distributions). 

Maximum Deductibility Limit

The employer may deduct a maximum of 25% of contributions based on overall eligible compensation. Unlike the individual annual additions limit, this is based on the aggregate compensation paid to employees who are eligible to participate in any of the plans. There is no specific limit for any one individual. This would include all company contributions made to any of the plans sponsored by the employer — the company match, profit sharing contributions, ESOP contributions, and ESOP loan payments. Note that this does not include the employee’s 401(k) contributions.

Top Heavy Determination

A plan is top heavy if 60% or more of the benefits are held by “key employees” (note that the definition of a key employee is not the same as a highly compensated employee). For purposes of this test, all plans of the employer must be included, and the account balances of the key employees in all plans are combined.

Other Plan Design Issues to Consider

  • Which plan will receive the matching contributions? The match could be made to the ESOP and could be used towards company stock. This would include 401(k) safe harbor contributions if the 401(k) is a safe harbor plan for nondiscrimination testing purposes. 
  • Will the plans have the same limitation year? It is usually suggested that they do.
  • Will the same compensation definition be used for all plans? It is permissible to define compensation differently among the various plans. For example, you may want to allow 401(k) deferrals on all types of compensation (including bonuses and commissions) but to exclude this for ESOP allocation purposes.
  • Will the plans have different eligibility requirements? The 401(k) plan might have immediate entry, while the ESOP requires a one-year wait.

Having multiple retirement plans can be desirable and very attractive to employees. However, careful planning is necessary to coordinate all of these pieces to avoid a violation. Please contact your Relationship Manager at Principal® for more information. 

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Insurance products and plan administrative services provided through Principal Life Insurance Co., a member of the Principal Financial Group®, Des Moines, IA 50392.

Principal, Principal and symbol design and Principal Financial Group are trademarks and service marks of Principal Financial Services, Inc., a member of the Principal Financial Group.