Definition of a Terminated ESOP Participant – Is the Terminated Participant “Disabled?”

It’s that time of year again. Time to put together year-end information for your third-party administrator. We get many questions on how some employee terminations are classified and what the appropriate distribution timing options are.

One of the more common questions is what classifies the participant as “disabled” for purposes of making what is generally a more accelerated distribution versus if the participant is deemed terminated for “other” reasons. The key to answering this question is to look first at how your ESOP plan document defines “disability.” Many plans include within the definition of disability a requirement that the participant either receive Social Security disability benefits, while others state that the participant need only be “qualified” for Social Security disability benefits. This is not true of every ESOP, so it is important to first review your plan’s definition.

The second part of the analysis is to look at whether there is discretion granted to the plan administrator within the ESOP’s definition of “disability” that permits the plan administrator to make the determination as to whether a participant is disabled for ESOP purposes. If that is the case, it will be important for the plan administrator to document how they reach their conclusion of disability.

The next step is to review the plan’s distribution provisions to determine what the distribution timing is for terminated participants based on disability. Plan distribution provisions generally differentiate the timing for a distribution resulting from termination due to disability or distributions for what is referred to as “other” termination (i.e., terminations for reasons other than death, disability or normal retirement). That analysis might also go one step further in determining whether the participant’s account should be segregated. Some plans do segregate only those accounts of participants who have terminated for reasons other than disability or for normal retirement so it is important to know the reason for the termination.

Your starting point for finding the answer is always a review of the plan document and/or the distribution policy for the ESOP, so that’s where you should look first.