Are you an NCEO member? Learn more or sign up now.

Home » Publications » Archived Publications »

ESOP Diversification Challenges for Private Companies

An NCEO Issue Brief

(Digital Version)

by Rebecca Hoffman

This is one of our archived publications; specialized publications that have been removed from our main publication list and are not being updated, but are are still available for purchase, although sometimes only in digital form.

This is provided as a PDF, with no shipping charges. It also is available in a print version (for which shipping charges apply).
$15.00 for NCEO members; $25.00 for nonmembers

A 20% quantity discount will be applied if you are a member (or join now) and order 10 or more of this publication. If you need to order more than the maximum number in the drop-down list below, change the quantity once you have added it to your shopping cart.

This ebook may not be resold or given away to others. If you would like to share this book with another person, please purchase an additional copy for each recipient. For example, if you want a copy for yourself and two colleagues, choose the quantity 3, add it to your cart, and check out. You will then download one copy that you can also provide to your two colleagues. Thank you for respecting our rights as an independent publisher.


NCEO members who supply their members area username and password during checkout can download digital publications like this one immediately after submitting an online order. Others will immediately receive a download link that will become live within one business day.

There is little guidance available regarding the diversification rules applicable to ESOPs, and some of the guidance available is at best extremely difficult to follow. The ESOP community wants to comply with the diversification requirements, but the guidance is vague in many areas, and the timing requirements are not practical. While awaiting clear and workable guidance, ESOP sponsors have developed a variety of approaches in hopes that these approaches and applied interpretations will be considered good-faith compliance approaches. This issue brief highlights common challenges in complying with diversification requirements in private companies and shares information about interpretations and procedures commonly used by ESOP sponsors.

Publication Details

Format: PDF, 34 pages
Dimensions: 8.5 x 11 inches
Edition: 1st (April 2014)
Status: Available for electronic delivery

Usage Rights for NCEO Digital Publications

When you download an NCEO digital publication that you purchase or subscribe to (or that someone purchases or sponsors for you), you may copy it to any computer or other electronic device you personally use, and you may print it for your own use. However, you may not share it with others unless you purchase a license to do so or buy a copy for each person.


Overview of Diversification Rules
The 90-Day Election Period
The 180th Day Processing Deadline
Years of Participation
Non-Employee Diversification
Eligible Diversification Amount Determination
Early, Extended, and Excess Diversification
Protected Benefit Questions
The De Minimis Rule
Participant Statement Requirements
Appendix A: Sample Notices and Forms
- Example for Election Option 1 (Preliminary Notice)
- Example 1 for Election Option 2 (Initial Revocable Election)
- Example 2 for Election Option 2 (Initial Revocable Election)
- Example 1 for Election Option 4
Appendix B: Sample Diversification Policy/Procedures
- Example Diversification Policy
About the Author
About the NCEO


From "The 180th Day Processing Deadline"

Under this approach, the diversification election is processed within the 180-day deadline but because the final amount cannot yet be determined, an estimated calculation is used. Plan sponsors that use this approach will most often true up the amount once the final amount is determined. If the estimate exceeds the final calculated amount, there is typically no downward adjustment because amounts have already been processed. This estimated approach is not used nearly as often as the above options, and when it is used, the company most often processes any remaining amount due once the final amount is determined. There is some risk that the estimate could result in an overpayment if the company stock value declined significantly, so to limit exposure, this factor must be considered when determining the estimated amount. If a true-up is not done, there is a risk that the participant and/or IRS can claim that the participant's diversification election was not fully satisfied. The companies that use this option focus compliance on the timing requirement and get most of the eligible diversification amount processed within the timing requirement.

From "Years of Participation"

Participants who have 10 years of plan participation and who have attained age 55 are eligible to diversify and are considered qualified participants for diversification purposes. So what is a year of participation for diversification purposes? First, it is important to recognize that there is no definition of a year of participation for diversification purposes provided by current guidance. Companies with an ESOP have used a variety of determination approaches. Some of the most common approaches used today are:

Counting all plan years in which a participant has an account balance for any portion of the plan year, including years after termination of employment until a complete distribution has occurred.
Counting only plan years in which a participant is eligible for contribution and/or forfeiture allocations. This might be designed to give credit only for a year in which there are amounts to allocate or credit might be given based on meeting the allocation eligibility criteria, regardless of whether there is anything to allocate.
Counting years of vesting service credited while a participant.
Treating all years of service for vesting purposes as years of participation, including vested service obtained before becoming a participant.
Using an elapsed time calculation from the first day of participation to complete distribution.

Most plans count years of participation on a plan year basis, but some use an elapsed time approach.

If assets from another plan are transferred into the ESOP and used to acquire stock, it is not clear whether the years of participation in the other plan must be counted for diversification purposes. In addition, if an existing plan is converted into an ESOP or merged into an ESOP, it is uncertain whether the years of participation before the conversion/merger must be counted for diversification purposes. Further, it is unclear in these circumstances whether using these transferred/merged/conversion balances to invest in company stock is a deciding factor and whether it makes a difference if the participant makes an election to invest such balances in company stock. Some IRS private letter rulings address specific issues, but these do not provide a comprehensive answer to many possible situations. Private letter rulings are specific to the plan sponsor that requested the ruling, and while they may provide some insight into how the IRS interprets qualified plan rules, they cannot be relied upon or used as precedent by any other plan sponsor.