New vesting requirements for your ESOP

As we approach the third month of 2007, it is time to revisit one of the changes made by the Pension Protection Act of 2006 (PPA) that may impact your ESOP and 401(k) plan.  As you may recall from an earlier post, one of the changes made by the PPA was to the vesting requirements applicable to all defined contribution plans, including ESOPs.

Prior to 2001, the permitted vesting schedules were the five year cliff vesting schedule, the seven year graded vesting schedule or another schedule as long as participant vested at least as rapidly as under the five year cliff or the seven year graded.

The provisions of PPA provide that any contributions made in plan years beginning after December 31, 2006 must vest under either the 3 year cliff or 6 year graded schedules. Another vesting schedule will still satisfy the PPA requirements as long as participants vest at least as rapidly as under the three year cliff or six year graded schedule.

PPA also provided for a special effective date for leveraged ESOPs. If the ESOP has a securities acquisition loan outstanding on September 26, 2005, then the vesting schedule change does not apply to any plan year beginning before the earlier of (1) the date that the loan is fully repaid, (2) or the date that the loan was scheduled to be fully repaid as of September 25, 2006. 

So unless the exception for leveraged ESOPs applies and your ESOP is a calendar year plan, the new PPA vesting schedule is in effect and would apply for those participants who may terminate in 2007. Thus, as the plan sponsor, you should be choosing the vesting schedule that you want to use for the post – 2006 plan years in the near future. In addition, you can have a couple of other choices that can be made.

PPA allows the faster vesting schedule to apply only to post-2006 contributions. However to apply the new vesting schedule to only post-2006 contributions would require separate accounting of amounts contributed prior to 2007 vs. amounts contributed after 2006. Many plan sponsors will choose to implement the change by applying the faster vesting to all amounts in the plan to avoid the need to separately account for pre-2007 and post-2006 accounts.

The faster vesting schedules can be limited to those participants who are credited with an hour of service in a plan year beginning after December 31, 2006. Thus, the faster vesting schedule need not apply to participants who have terminated prior to the effective date of the vesting change.

So to summarize, you have the following decisions to be made with respect to your vesting schedule (assuming your current vesting schedule is not rapid enough):

• Which vesting schedule will you use?
• If you are a leveraged ESOP, do you want to delay the change in vesting schedules as allowed under the exception outlined above?
• Do you want to apply the new vesting schedule to all balances or only to amounts accumulating in post – 2006 plan years?
• Do you want to limit the application of the new vesting schedule to participants who have an hour of service in the first plan year beginning after December 31, 2006?

Your plan document does not need to be amended to reflect these decisions until the end of the 2009 plan year. Nevertheless, you may choose to adopt an amendment now to record the decisions made and you may also want to communicate the new vesting provisions to your employees at this time.