Employee Stock Ownership Plans and "Rebalancing"

In response to an April 3, 2009 Request for Technical Assistance the Internal Revenue Service made it clear that the right to be invested in employer stock is not a protected benefit.  The memorandum went on to address the issue of rebalancing in an ESOP, which is defined as “the mandatory transfer of employer securities into and out of participant plan accounts, usually on an annual basis, designed to result in all participant accounts having the same proportion of employer securities.”

In the memorandum, the IRS noted that mandatory transfers of stock within a plan are permitted under the Internal Revenue Code as long as the transfers satisfy the nondiscrimination requirements of the Regulations.  It specifically noted, though, that rebalancing will not raise issues of current and effective availability because it treats all participants the same.

Rebalancing is only applicable to an ESOP that has “other investments” in addition to employer stock.  When a plan allocates new shares each year to participants (or newly released shares as an exempt loan is paid off), eventually all shares are purchased and allocated.  After that time, new participants only share in the allocation of cash contributions or reallocated forfeitures.  Employees who have been with the company since the ESOP was established end up with a larger concentration of their accounts in company stock, while those who have only been in the plan a short time have a small percentage of their accounts invested in company stock.  

In anticipation of this result, some employers provide in the ESOP document for periodic rebalancing so that all participant are proportionately invested the same in company stock.  For example, instead of some participants being 95% invested in company stock and others being 10% invested in company stock, the plan will rebalance the assets so that all participants are 85% vested in company stock.

Advantages: There are several advantages to such a provision.

  • All participants have the same yield in their accounts. If every participant’s account is 85% invested in company stock and 15% invested in other investments, then every participant’s yield is the same. This avoids situations in which there are dramatic differences in yields seen by participants – such as when the company stock increases 25%, the other assets earn only 5%, and rebalancing is not being used.
  • Increased diversification reduces portfolio risk. Although participants have the right at age 55 with 10 years of participation to start diversifying out of company stock, rebalancing allows additional diversification at an earlier point in time.
  • Rebalancing provides an equal incentive and reward to all participants who are sharing in the success of the company through the ESOP.

Disadvantages: There are also disadvantages to rebalancing in an ESOP.

  • Unless rebalancing is put in the plan when it is initially established and then properly communicated, the participants who have shares transferred out of their accounts in order to accommodate rebalancing may perceive it as a “take-away”, especially when the company stock consistently outperforms the other investments.
  • It can be complicated to explain to plan participants the difference between forced rebalancing and optional diversification at age 55 with 10 years of participation.
  • If the ESOP has other assets, current employees might prefer that the employer purchase shares from former employees who have not yet been paid their benefits instead of transferring stock from the current employee accounts. Such a transaction is referred to as “reshuffling.” Of course this could be seen as a disadvantage to the former employee who wants to leave his balance in the plan invested in company stock until retirement age.
  • In some ESOPs, terminated participants must have the right to a distribution in employer securities. This means that if the participant’s account has been divested of company stock as a result of rebalancing or reshuffling, he may still request a payout in the form of company stock, in which case the plan will have to transfer shares back into his account in order to effectuate the distribution. However, some ESOPs can preclude distribution in company stock, namely those that are sponsored by S corporations as well as those that are sponsored by companies whose by-laws require that non-ESOP shares can only be held by employees.

The IRS memorandum addressing the issue of rebalancing indicated that any plan provision allowing the mandatory transfer of stock must have language that explains to the Administrator how to determine the number of shares or amount of cash to transfer in and out of the accounts. It also stated that if a participant chooses to diversify any portion of his account out of company stock, the plan cannot use rebalancing to mandatorily transfer stock back into the participant’s account.

Rebalancing is an ESOP investment strategy that requires careful consideration and administration. If you would like additional information about utilizing this option in your ESOP, please contact your Account Executive at RMS.




Amber M. Lloyd, Managing Member and Owner of RMS, began her career in retirement plan administration and consulting in 1994. She graduated from the University of Kentucky with a Bachelor of Business Administration with high distinction and departmental honors in Finance and over the years has become credentialed as an Accredited Pension Administrator, a Chartered Mutual Fund Counselor designee, a Certified Financial Planner™ certificant, and an Enrolled Retirement Plan Agent. Throughout her 26 years in the retirement field, she has worked on all types of retirement programs, including both qualified and nonqualified plans and often speaks on retirement plan topics. Amber is an active member of the National Institute of Pension Administrators, the ESOP Association (where she currently serves as a VP for the KY Chapter), the National Center for Employee Ownership, the ESOP Marketplace, and the Financial Planning Association (where she currently serves as the Secretary/Treasurer for the FPA of Kentuckiana Chapter Board and was the 2018 President). She is also Past President of the Louisville Employee Benefits Council and former Board Member for Mummers & Minstrels, a local non-profit community theatre group. Amber currently devotes most of her time to new business development, consulting on 401(k), Profit Sharing, and Employee Stock Ownership Plans and heads up the firm’s ESOP Practice Group.


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