What means ESOP?

Published by Thomas Herold in Investments, Laws & Regulations, Retirement

'ESOP' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

An ESOP stands for the Employee Stock Ownership Plan. These are not exactly retirement savings accounts in the traditional sense. They are critical investment vehicles with tax advantages. With these types of accounts, employers establish a trust fund for the employee. The employer is then able to transfer shares of its own stock to this fund.

They might alternatively allocate cash with which the employees’ account can purchase already existing shares of stock. These ESOPs prove to be the most typical means for employees gaining part ownership in their company within the United States.

Every company has its own unique formulas for allocating shares to its participating employees. The shares come out of the company trust account and transfer over to the appropriate individual employee accounts. As with other benefits for employees that are employer sponsored, vesting rules apply.

Gaining full vesting in stock option accounts requires the employee to reach a minimum number of years at the company. Once this seniority level and vesting is obtained, the employee fully owns the shares and may sell them at will. When employees part with the company, the vested shares of stock have to be purchased from them at the full market price.

There are also tax benefits to these stock option plans. Companies that issue them accrue the advantages of tax deductions for the stock value. Employees do not have to pay any taxes on employer offered contributions. They are also able to transfer the distributions to IRAs or other qualified retirement vehicles. This will help them to avoid realizing capital gains or income taxes.

These stock option plans do have limitations and rules pertaining to rollovers and withdrawals. Distribution rules can be different from one employer to the next. In general the distributions are allowed to be rolled over to other retirement plans which are qualified. Any person with an ESOP will find the distribution rules detailed in the Summary Plan Description section.

As with 401(k)s and other types of retirement vehicles, penalties for early withdrawals do apply. An employee must be 59 ½ to begin receiving non penalized distributions. These distributions become mandatory on the April 1st that follows the year the employee reaches 70 ½. Companies have the choices of making these account distributions with cash, stocks, or a combination of the two.

Regardless of the way they give them out, employees are always allowed to sell back vested stock shares. The proceeds from these sold shares can be transferred into self directed or traditional IRAs to defer taxes. They may also roll or transfer their distributions to a different company’s qualified retirement savings vehicle. The money will only become taxable at ordinary income tax rates once it is withdrawn later.

Participants in these stock option plans are not able to purchase any types of gold investments with the distributions. The only exceptions are when an employee has obtained diversification rights from his or her employer. Normally only employees of gold mining companies would be able to acquire either paper or physical gold in such a retirement savings account.

Because of these limitations, rolling over distributions from a stock option account to a self directed IRA makes sense. Once the funds are in a self directed account, the holders will be able to choose where they invest these funds. They will then have a variety of tax free alternative investments such as gold and other precious metals.

There are a few downsides to the employer established and funded profits sharing plans. Investment choices are as limited as can be imagined. The account owner also has to complete the company’s vesting schedule. This means that the employees can only access their funds once the vesting period of years has elapsed. ESOP’s also carry risks specific to the employee’s company. Should the employer go bankrupt, the plan may become closed. An employee might no longer be allowed to contribute to the plan or account at this point.

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The term 'ESOP' is included in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.