How Does an ESOP Work?

An employee stock ownership plan, commonly known as an ESOP, is a retirement plan that is somewhat similar to a 401(k). However, an ESOP is usually company-funded with stock from the employer. Although ESOPs have been in use for years, misconceptions exist as to how an ESOP works.

Forming an ESOP

The employer company sets the ESOP in motion by creating an employee stock ownership trust (ESOT), which is sometimes called an “ESOP Trust.” The ESOP typically acts as a qualified retirement plan with some significant differences. For example, unlike most other retirement plans, ESOPs are permitted to borrow money to purchase the company’s stock used to fund the trust.

Most full-time employees over age 21 can participate in an ESOP.

Funding the ESOP Trust

The employer company funds the ESOP Trust typically using one of the following methods:

  • By contributing company stock, or
  • By having the ESOP borrow money to buy the shares.

The second method results in a leveraged ESOP. The employer usually makes payments to the ESOP Trust to pay off the loan. In most cases, the employees do not buy the shares themselves.

ESOP Management and Allocation

The trustee of the ESOP trust manages the trust assets, which may include buying and selling shares as needed.

In addition, the trustee distributes ESOP shares to the participants’ individual employee retirement accounts. However, the process is slightly different with a leveraged ESOP. Here, the share allocation takes place as the ESOP trust repays its loan.

Employees now have shares of stock in their retirement accounts and are part owners of the company. In fact, some ESOPs eventually own most or all of the employer company’s stock.

ESOPs Offer Significant Benefits

Employees typically are able to accrue larger retirement accounts than through more traditional methods. In addition, ESOPs often provide continuity of ownership, which may save jobs and promote the continued operation of the business.

Companies benefit also. Because of the ESOP, in some situations management has the necessary resources to keep the business afloat while looking for an investor to buy out their shares.

Learn More About ESOPs

Employees who participate in ESOPs often are able to accrue more benefits than through other methods. Employers also may receive significant tax advantages by including an ESOP in their employee benefits planning.

At Hall Benefits Law, we work extensively with employee benefit plans including retirement plans and ESOPs. Please call 678-439-6236 to discuss your concerns with an experienced attorney. Our website contains more information about our firm, a Contact Form, and free resources for your review. From our home office in Georgia, we assist clients throughout the United States, from North Carolina to Oregon.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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