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May 22, 2001
This Week, Ted Tackles: My wife's employer contributes to her flexible spending account, and she is allowed to put this contribution in her 401(k) plan. Will this money count against her $10,500 annual contribution limit? ... Our company wants to convert our Employee Stock Ownership Plan (ESOP) into a 401(k). What are the implications of doing this?
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Question: My wife's employer contributes a total of
$1,000 to each employee's flexible spending account. The employee chooses whether to
allocate it to a medical spending account, dependent-care spending account or 401(k). This
is in addition to her regular 401(k) contributions with company match. If I understand
correctly, the maximum an employee can contribute to his or her 401(k) for this year is
$10,500 and employer-matching contributions don't count against that limit. Will this
contribution count against my wife's $10,500 limit?
TB: You are correct that the $10,500 limit applies
only to employee pre-tax contributions. This limit is set by law and appears in Internal
Revenue Code Section 402(g).
The amount the employer contributes must be combined with
all employee contributions to make certain the combined contributions do not exceed a
different limit contained in Internal Revenue Code Section 415. This limit is 25 percent
of compensation, not to exceed $35,000.
The contribution your wife's employer makes to the flex
plan is considered to be an employer contribution, which means it counts toward the latter
rule, the 25-percent-of-pay limit, and not the $10,500 rule.
Question: Our company wants to convert our current
employee stock ownership plan (ESOP) into a 401(k). What are the implications of doing
this?
TB: There are a variety of ways this can be done.
The implications of the change depend on how the conversion is accomplished. The major
issue is whether this change is being done to increase or to decrease employee ownership
of company stock.
I'm assuming that you don't have a 401(k) currently and
your employer is planning to add this feature. Further, I'm going to attempt to cover two
possible scenarios, one in which your employer wants to reduce the amount of company stock
employees are currently holding, and the other in which your employer wants to increase
the amount of company stock ownership among employees. In most cases, an ESOP is a benefit
fully funded by the employer.
If the company's goal is to reduce employee
ownership of company stock, one approach would be to add a new pre-tax employee
contribution that employees could invest in a new broad offering of investments that may
include company stock. (The goal, however, would be to have the employees direct their
contributions to the other investment options.) Employees could also have the opportunity
to sell their shares of employer stock in order to diversify their holdings. In this
situation, employees could gain the ability to direct the investment of the employer
contribution as well as their own contributions.
If the goal is to increase employee ownership of
company stock, the employer could also add a new pre-tax employee contribution that could
be used to purchase company stock. The employer should also provide at least three other
investment options for employee contributions, if it wants the 401(k) plan to comply with
the voluntary 404(c) section of ERISA. The goal in this case, however, would be for
employees to direct their contributions into company stock. Employer contributions would
continue to be invested in company stock.
In either event, there are many issues related to the
ownership of company stock. The following are some that come to mind:
- The plan will have to be registered with the Securities and
Exchange Commission (SEC) if employees will be able to invest their money in company
stock.
- Employees should not be encouraged or pressured to buy
company stock. It should merely be made available as an additional investment choice or
benefit.
- Employees should be informed of the additional risk
presented by owning too much of a single stock in their portfolios.
- Special administrative procedures will be needed to handle
transfers between company stock and other investments because the settlement rules for
stocks and mutual funds are different.
- The company stock must trade on a daily basis for the plan
to comply with Section 404(c) of the Employee Retirement Income Security Act (ERISA).
- You will have to monitor the insider-trading rules for stock
held in the plan.
Ted Benna, creator of the first 401(k) retirement savings
plan, will answer your most intriguing questions every Tuesday. With over 30 years of
experience as an employee benefits consultant, Ted is a nationally recognized expert on
benefits issues. He has authored two books, Helping Employees Achieve Retirement Income
Security and Escaping the Coming Retirement Crisis, and is President of the
401(k) Association. Ted is a frequent speaker at meetings of 401(k) plan sponsors and
participants. His articles and comments have appeared in numerous publications, including The
New York Times and The Wall Street Journal.
 Read Ted Benna's Biography
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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