An ESOP is a retirement plan that provides a company’s workers with an ownership interest in the company. With an ESOP, companies provide employees with stock ownership, typically at no cost to the employees.
The company may borrow money to facilitate the purchase of ESOP, which can be repaid by contributions that the ESOP receives from the company. Shares of stock are then allocated to employee accounts based on their compensation levels.
Shares held in an ESOP remain in the trust until an employee retires or leaves the company, or exercises earlier diversification opportunities, creating an opportunity for workers to accumulate long-term savings through their work.
An employer can contribute up to 25% of the total compensation of all eligible employees. The maximum amount which can be allocated to any one participant is 100% of the participant's compensation, or $55,000, whichever is less. The $55,000 limit is adjusted each year to reflect changes in the cost-of-living index.
Advantages to ESOP plans include:
- ESOPs help business owners gradually begin the process of converting their closely held ownership into liquid, diversified capital.
- An ESOP is an ideal vehicle by which to vest employees in your company and boost morale.
- Tax and investment benefits are numerous. For example, a loan used to finance an ESOP transaction is effectively repaid by the company with pre-tax dollars. For S-Corporations, the ESOP’s share of recognized earnings are tax exempt.
Disadvantages to ESOP plans include:
- The requirement of filing a Form 5500 annually.
- Regular appraisals are required to value the shares of stock.
- Shares in ESOP trusts accrue disproportionately to employees who enrolled earlier. Newer employees at ESOP companies can be left without much opportunity to participate in the program.
- An ESOP is obligated to buy back the stock of departing employees. If many of the employees are near retirement age, this could create a cash burden on the company and/or its ESOP.
Is an ESOP the right tool for your company?
JC Actuarial Benefit Consultants, Inc. will help you choose the type of plan that will benefit your employees, maximize your tax savings and help your retirement assets reach their fullest potential.