Best Practices for ESOP-401(k) Combinations, 2nd Ed.
Updated coverage of the issues that arise when a company sponsors both an ESOP and a 401(k) plan.
By Lisa A. Durham, Dawn Hafner, and Dolores Lawrence
Format
Description
Most companies with an employee stock ownership plan (ESOP) either sponsor a separate 401(k) plan or combine ESOP and 401(k) components together under the umbrella of a single plan arrangement known as a KSOP. The combination of plans offers employees the ability to diversify the investment of their retirement savings through the 401(k) arrangement while enjoying the benefits of ownership through the ESOP. However, many administrative and legal issues arise, and it is crucial for both companies and service providers to understand them, beginning in the plan design stage. This book, written by three experienced practitioners with backgrounds ranging from law to administration and updated as of 2025 for the second edition, discusses a wide range of essential issues and the best practices for dealing with them.
Table of Contents
An Introduction to ESOP/401(k) Combinations
Key Differences Between ESOPs and 401(k) Plans
Important Considerations for the Company Sponsoring Both Plans
Employer Contribution Deduction Limits
Annual Addition Limits
Top-Heavy Testing
"Highly Compensated Employee" Definition
Multiple Plan Coordination
Fiduciary Responsibility
Vendor Fee Disclosures
Participant Fee Disclosures
General Design Options
Side-by-Side Plans - Minimal Integration of Features
Match in the ESOP
Safe Harbor Contributions in the ESOP
Transfers Between Plans: Beware of the Landmines
SECURE Legislation and Plan Design
KSOP Design
Considerations in Designing the Second Plan
Adding an ESOP When a 401(k) Plan Already Exists
Adding a 401(k) Plan When an ESOP Already Exists
Stand-Alone Plan or KSOP?
Communication Challenges
Conclusion
Appendix A: ERISA Section 408(b)(2) Vendor Fee Disclosure Rules
What Does This Mean for an ESOP (or KSOP) Sponsor?
Appendix B: ERISA Section 404(a)(5) Participant Fee Disclosure Rules
Items to Be Included in Initial and Annual Disclosures
Action Items for Affected ESOPs or KSOPs
About the Authors
Excerpts
From chapter 2, "Important Considerations for the Company Sponsoring Both Plans"
If a company is using a different TPA for each plan, it is important to have one TPA assigned the responsibility of calculating the combined Section 415 annual additions for each participant in a limitation year and determining the appropriate corrections if any participant’s allocations exceed the annual limit. If a company sponsors more than one plan, the plans should include coordinating language that dictates in which plan the Section 415 excess contributions are corrected.
What if a company sponsors a 401(k) plan with a calendar limitation year, plus an ESOP with a limitation year ending each September 30? In that situation, two Section 415 calculations would be needed annually to capture the total allocations to an individual’s accounts in each limitation year! If two plans have different plan years, the plan sponsor should consider drafting the plans to have the same “limitation year” so that only one annual Section 415 calculation is needed.
From chapter 3, "General Design Options"
The original SECURE Act was enacted in December 2019. SECURE 2.0 was enacted in 2022. The new provisions included a myriad of required and optional provisions with staggered effective dates. Those included changes in minimum distribution rules, salary deferral catch-up contributions, and much more. Many changes are optional, such as matching contributions on student loan repayments and emergency savings accounts. Roth accounts are no longer subject to required minimum distributions (RMDs). Many of the optional provisions may be considered for 401(k) plans but are unlikely to be a good fit for ESOPs or may not apply to ESOPs at all.
Some provisions that may result in a headache for the ESOP sponsor and/or TPA:
- Super catch-up contributions. Starting in 2025, a 401(k) plan may permit higher catch-up salary deferrals for participants aged 60 to 63. For 2025, the normal age 50 catch-up deferral limit is $7,500. The super catch-up limit is $11,250. It will be important for plan sponsors to identify the catch-up amounts for their TPAs so that Section 415 annual additions can be calculated. (See separate discussion below on annual additions.)
- Roth catch-up contributions. Beginning in 2026, certain high-paid participants can make catch-up contributions only if they are Roth deferrals. “Highly paid” participants are defined by reference to their FICA wages in the prior year. For example, in 2026, a highly paid participant is 50 years old or older and had FICA wages over $145,000 in the previous calendar year. How does that affect an ESOP? Suppose Joe Participant’s contributions from all plans (annual additions) exceed the Section 415 limit in 2026. Joe, aged 55 and a highly paid employee, made salary deferral contributions of $20,000 in 2026. At first glance, Joe did not make any catch-up contributions from his pay. Can the ESOP TPA recharacterize a portion of his deferrals as catch-up?
- Roth treatment for employer contributions. SECURE 2.0 makes it possible for a company to amend plan provisions and permit participants to designate matching or nonelective contributions as Roth contributions. For Roth treatment, the contributions must be 100% vested. Participants are taxed on the contribution amounts when allocated to their accounts. Could this be implemented in an ESOP? Technically, yes, and we do have some IRS guidance on this option. However, 401(k) and ESOP service providers must deal with understanding the mechanics, the work involved in tracking Roth accounts, and the software changes needed for recordkeeping systems. Expect slow adoption and implementation, and higher service provider fees.