Combining ESOPs and 401(k) Plans

Most companies that sponsor an Employee Stock Ownership Plan (ESOP) also sponsor a separate 401(k) plan.  Alternatively, some companies sponsor a “KSOP”, which is a plan that has both ESOP features and 401(k) features.  KSOPs make up a very small percentage of all defined contribution plans; but where they are utilized, it is most commonly a publicly traded company that puts its 401(k) match in employer stock. The KSOP document must specify the portion of the plan that is an ESOP; and the ESOP portion of the plan continues to be subject to all the rules that apply to stand-alone ESOPs.

For employers who sponsor both an ESOP and a 401(k) plan, the question is sometimes asked – Why not merge the two plans and create a KSOP?  This article will address the pros and cons of such a merger of plans.


  1. Most of the advantages of an ESOP continue to apply, at least to the ESOP portion of the KSOP.  Combining two plans into one can reduce the number of plan documents, Forms 5500 filed each year, determination letter filings, IRS user fees, and (for larger plans) fees related to the annual accountant’s opinion.
  2. If the two parts of one combined plan can be shown on one participant statement, then the employee gets to see a larger grand total than if the two plans are administered separately.  This may provide a morale boost for employees.


  1. Many of the vendors and institutional trustees that are willing to handle 401(k) plans fear the liability associated with handling employer securities, especially if not publicly traded.
  2. With healthy contributions to the ESOP, many companies intentionally choose more restrictive eligibility provisions, vesting schedules, definition of vesting service, and rules for distribution timing for the ESOP, compared to the 401(k) plan. Communicating the different provisions can then be complicated.
  3. For publicly traded companies, the Pension Protection Act (PPA) prohibits plans from forcing investments into employer stock.  Participants must be allowed to diversify their 401(k) contributions immediately.  Participants with three or more years of service must have the right to diversify all accounts.  If the plan invests in employer securities, then it must also offer at least three materially different alternative investment options. Some ESOPs are exempt from these rules but the exemption for ESOPs only applies to ESOPs that are stand-alone ESOPs with no 401(k) deferrals or matching contributions.
  4. When merging a 401(k) plan and an ESOP, if the 401(k) is older, 401(k) years of participation will be counted toward the age 55 & 10 years of participation rule for diversification.  If excluding years prior to the formation of the ESOP itself, the document should state this and the plan should get an IRS determination letter.
  5. In closely held companies, where the stock is typically appraised only once per year, combining the ESOP with the 401(k) plan (for which investment values are typically updated daily) can confuse participants.  They may not understand why the company stock is not simply an investment option like all other funds, or why its value only changes once per year.
  6. There are certain areas where many practitioners feel the federal government has not yet offered sufficient guidance to create a level of comfort for KSOPs sponsored by non-publicly traded companies.

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