Benefits of funding an employer match and/or safe harbor contribution in an ESOP

Roughly 90% of companies with an employee stock ownership plan (ESOP) either sponsor a separate 401(k) plan or combine ESOP and 401(k) components together under a single KSOP plan.

An ESOP can be used as the vehicle for receiving the employer’s matching contributions in the form of employer stock.  A formula can be written into the ESOP permitting the employer to match employee elective deferrals made to the employer’s separate 401(k) plan.  This allows the employer to make a cashless matching contribution to fund the match.  Most ESOPs provide for an annual match with year-end restrictions.  Employers often make a larger match than they would otherwise fund in the 401(k) plan, thus encouraging greater 401(k) participation by rank-and-file employees.

Companies may wish to avoid ADP/ACP testing by adopting a “safe harbor 401(k)” provision.  In a safe harbor plan, employer contributions are required and are 100% vested.  While safe harbor contributions are usually funded in a company’s 401(k) plan, they can instead be funded in the ESOP.

The safe harbor rules specify that a plan, other than the 401(k) plan, can be designated as the plan that receives the safe harbor contribution.  401(k) safe harbor matching contributions, non-elective contributions and even a qualified automatic contribution arrangement (QACA) can be made to a separate ESOP plan, provided that this is clearly spelled out in the ESOP and the eligibility provisions of the ESOP correspond to the eligibility terms for participation in the 401(k) plan’s elective deferral feature.

If the ESOP is leveraged and shares are being released from an exempt loan suspense account, then the matching or 401(k) safe harbor contribution can be satisfied by using one of two methods:

  • ESOP contributions are allocated to participant’s accounts as a cash contribution in the amount of the 401(k) safe harbor or matching contributions. This contribution is made within the ESOP and used to make payments on the exempt loan.
  • The second method applies cash contributions to the loan, releasing shares based on their Fair Market Value (FMV), to meet the amount of the desired matching allocation. This method is best used in years for which the FMV of the shares being released exceeds the loan payment made to release the shares.

Combining an ESOP with a 401(k) plan (KSOP) can lower plan costs to the employer; one Plan Document, one Summary Plan Description, one Form 5500 filing, one plan audit (if required) and may result in increased plan benefits to the employees.

Please let us know if you have questions about funding an employer match or safe harbor contribution into the ESOP. If you have someone in your personal network that would like to discuss this, please let us know.

For more information on KSOPs, visit:  www.esopassociationorg or www.nceo.org

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