Retirement plan: ESOP

We have seen that an Employee Stock Ownership Plan (ESOP) can benefit the owner(s) of the company.

But what’s in it for the employees?

An ESOP is a retirement plan in which the company contributes its stock (or money to buy its stock) to the plan for the benefit of the company’s employees. It allows employees to become beneficial owners of the stock in their company.

ESOPs are tax exempt trusts that acquire, hold and/or sell the company’s stock for the benefit of participants in the ESOP, the employees. In general, the company borrows money and then loans the ESOP trust fund for the purpose of acquiring shares. As the ESOP loan is paid down, shares are allocated to employee accounts annually, usually in proportion to the employee’s annual compensation. Upon retirement, termination, disability, or death, employees receive cash in exchange for their shares.

Just as in every other form of qualified pension plan, employees do not pay taxes on the contributions until they receive a distribution from the plan when they leave the company. They can roll the amount over into an IRA or other retirement plans or pay current tax on the distribution, with any gains accumulated over time taxed as capital gains. The income tax portion of the distributions, however, is subject to a 10% penalty if made before normal retirement age.

The ESOP provides benefits to the participants if the underlying shares are determined to have value. Therefore, good management and operation of the business is critical to creating a successful ESOP company.

I created this blog to help understand certain basic aspects of U.S. tax law. Of course, each situation is unique and nothing that is on this site will ever replace the expert advice of a tax professional.

Please do not hesitate to contact me should you have any question