What are the vesting rules for ESOPs?

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In all defined contribution and defined benefit plans, vesting must be complete when the employee reaches normal retirement age, defined as the retirement age specified in the plan or the later of the time the participant reaches age 65 and has five years of participation in the plan.Employees must also be fully vested in the case of a full or partial plan termination.Plans are not required to do so, but many provide for full vesting upon disability, death, or reaching the early retirement age specified under the plan.Vesting requirements depend on four factors:a. Whether the contributions are made for plan years starting after December 31, 2006, or,b. If there are shares acquired by an ESOP loan in effect as of September 26, 2005, or,c. Whether the plan is top-heavy or,d. Whether the plan is being used under the safe-harbor test for matching contributions to 401(k) plan.NOTE: the following information reflects provisions in the pension reform bill passed by Congress in July, 2006.All defined contribution plans must vest their shares no later than after three years for cliff vesting and six years for graded vesting, starting at no less than 20% per year after two years of service. If there is an ESOP loan in place as of September 26, 2005, the new rules do not apply to shares acquired by the loan for any plan year beginning on the earlier of the date the loan is fully repaid or the date on which the loan was scheduled to be repaid as of September 26, 2005. There is no consensus yet on whether this exception applies only to the shares acquired by the loan or any shares in the plan as of this date. Our recommendation is to take the more cautious approach and limit the exception to the shares acquired by the loan, but the literal language of the law can be read differently.Faster vesting schedules are required if plans are &#34;top heavy.&#34; See the question on &#34;Top Heavy Rules&#34; for details. Faster vesting is also required if the company is using the safe harbor matching contribution rule that allows companies to avoid anti-discrimination testing by making minimum contributions to the 401(k) plan, in which case contributions must vest immediately. These safe harbor rules allow a company to avoid testing if it contributes at least 3% of pay to all participants (regardless of what they defer) or a 100% match for the first 3% employees defer and a 50% match for deferrals between 3% and 5% of pay. In that case, these contributions must vest immediately.If the ESOP is used as a 401(k) match in a plan with an automatic enrollment feature, still other rules apply. The new automatic enrollment provisions for 401(k) plan in the Pension Protection Act provides that companies can meet the 401(k) testing rules if they provide automatic enrollment (that is, employees opt out instead of opting in) that has the following features:1. There are matching or non-elective employer contributions to the plan of not less than at least 3% of pay for all participants, regardless of deferrals or a match, or at least a 100% match for the first year and 50% match for the next 5% deferred. The matching percentage test applies to deferrals of non-highly compensated employees.2. Employees agree to a minimum salary deferral of 3% in the first year, 4% in the second, and 5% in the third.If these rules are met, the vesting for the employer contributions can be two years, rather than immediate, as in the existing safe harbor match for contributions to 401(k) plans without automatic enrollment.For a detailed description of the rules and uses for ESOPs, see Understanding ESOPs.