BankDirector.com: Charting a course for America's banking leaders

BankDirector Cover

Committees : Compensation

Should our 401(k) Get Married?

February 8th, 2013 |

CCR_2-8-13.pngRetirement plans are viewed by many bank boards as necessary to retain employees and keep up with the competition. Costs are weighed against benefits, real and perceived. How should private banks and holding companies view their 401(k) while looking to minimize costs and maximize benefits?  One way is to marry the 401(k) provisions with employee stock ownership provisions in a single plan: a 401(k) + Employee Stock Ownership Plan or KSOP.

Should a Retirement Plan Own Closely-Held Shares?

The ability to purchase shares in a closely-held bank or bank holding company using the company’s tax-deductible contributions and dividends does not mean that it is universally the right thing to do.  First, no employee money should be used to purchase stock—funding will be entirely with employer-directed dollars. Efforts to structure programs using employee money to buy private stock are fraught with fiduciary and legal concerns (remember Enron?). Four major strategic considerations in using a qualified plan to purchase shares are:

  1. Is there a need to buy shares back?
  2. Will the required independent valuation of the shares reflect a fair market value acceptable to sellers?
  3. Will the tax favors and incentives of employees having beneficial ownership in some shares in the company warrant the costs?
  4. Does the company have the discretionary earnings to make such purchases, even on an untaxed basis, given the need for capital?

If the conclusion is that the tax-exempt private stock market is appealing, how does the KSOP work?

Key KSOP Operational Features 

A KSOP is a single plan document defining the two major components: 1) The employee savings deferrals making up the employee-directed accounts, and 2) The company contributions and dividends comprising the employer-directed accounts.

All the customary 401(k) features for employees can be retained—i.e. vesting, distribution rules, hardship loans, array of investment choices, daily valuation etc. for the employee directed money. The employer money can now be used to make contributions in cash or stock to the plan, with features of the company stock accounts now reflecting ESOP rules.

For example, if the employer match is made in the form of stock, the matching shares are allocated to all plan participants who participate in the deferral program. This is often done by employers wanting high employee participation. Rules restrict benefits that skew heavily to highly compensated individuals, and this broad participation can allow the more highly-compensated employees to defer more because it allows the firm to pass non-discrimination tests required for these plans.

The usual mechanism of a safe harbor 401(k) plan requires immediate 100 percent vesting of all contributions and employer matching contributions. Contributions can be matched at 3 percent of pay, or dollar for dollar up to 3 percent and then 50 percent on the next 2 percent of pay. The match goes to even non-participating employees.  

We have seen non-safe-harbor matches made with stock to avoid these rules and still provide sufficient incentives for broad participation.

Four Basic Pros:

  1. The company sponsors a single plan, which for companies with more than 100 employees requiring plan audits, reduces the cost to a single audit.
  2. The company can make matching non-cash contributions in the form of stock.
  3. The company can use cash accumulated in the employer-directed accounts to buy shares from any source—even newly-issued stock for capitalization purposes.
  4. As opposed to separate administration of two plans (often by different vendors), the consolidation of the process in a single plan can simplify management of the retirement plan.

Three Basic Cons:

  1. With often different rules for the ESOP and 401(k) components of one plan, care must be taken to avoid participant confusion.
  2. An independent valuation of the employer stock is required—something done annually, as opposed to the typical 401(k) daily valuation platform, which can also be a source of misunderstanding.
  3. The stock will incur an obligation for the company to repurchase shares for cash in the future.

Conclusion

Banks and bank holding companies needing a controlled market for their shares and reduced retirement plan costs, while retaining or improving employee retirement benefits, should consider a marriage allowed in the tax code between 401(k)s and ESOPs. Yes, there are complications, but the IRS will get its pound of flesh, either in complexity or dollars. Choose wisely.

mcoffey

Michael Coffey is the managing vice-president of Corporate Capital Resources. He is responsible for the design and oversight of stock transactions, business succession and executive compensation strategies for closely-held corporations. You can reach him at Michael_coffey@ccrva.com.

 

ltilley

Lisa Tilley is the senior management consultant for Corporate Capital Resources. Lisa develops and coordinates the design effort with her client's team of professionals in law, banking, insurance and financial services. You can reach her at lisa_tilley@ccrva.com.

 

blog comments powered by Disqus