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Employee Stock Ownership Plan (ESOP): What It Is, How It Works, and Advantages

By 澳洲幸运5官方开奖结果体彩网:Akhilesh Ganti

Updated November 05, 2024

Reviewed by

Samantha Silberstein

Fact checked by

Michael Rosenston

Definition

A﷽n employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company in the form of shares of stock.

Wha🧸t Is an Employee Stock Ownership Plan (ESOP)?

An Employee Stock Ownership Plan (ESOP) gives the sponsoring company—the selling 澳洲幸运5官方开奖结果体彩网:shareholder—and participants various tax benefits. It's a 澳洲幸运5官方开奖结果体彩网:qualified retirement plan. Employers often use them as a 澳洲幸运5官方开奖结果体彩网:corporate finance strategy to align the🀅 in🐓terests of their employees with those of their shareholders.

An ESOP is usually formed to facilitate succession planning in a closely held company by allowing employees the opportunity to buy shares of the corporate stock. ESOPs are also offered as a 澳洲幸运5官方开奖结果体彩网:retirement benefit.

Key Takeaways

An employee stock ownership plan (ESOP) is an employee benefit that gives workers ownership interest in the company in the form of shares of stock.
ESOPs encourage employees to give their all as the company’s success translates into financial rewards.
They also help staff to feel more appreciated and better compensated for the work they do.
Companies typically tie distributions from the plan to vesting, which gives employees rights to employer-provided assets over time.

How Doesꦐ an Employee Stock Ownership Plan (ESOP) Work?

ESOPs are set up as 澳洲幸运5官方开奖结果体彩网:trust funds. They can be funded by companies putting newly-issued shares in them, by putting cash in to buy existing company shares, or by borrowing money through the entity to buy companꦫy shares. ESOPs are used by companies of all sizes, including a number of large, publicly traded corporations.

Companies with an ESOP must not discriminate and are required to appoint a trustee to act as the plan 澳洲幸运5官方开奖结果体彩网:fiduciary.

Advantages of ESOPs

Since ESOP shares are part of the employee’s 澳洲幸运5官方开奖结果体彩网:remuneration package, companies can use ESOPs to keep plan participants focused on corporate performance anꦍd share price appreciation.

Employees, meanwhile, are presented with a way to make more money, increase their compensation, and essentially be 𒅌🅘rewarded for their hard work and commitment.

Important

ESOPs incentivize emplo♊yees to give their all and thu𝓡s can favor all parties.

ESOP Up-Front Costs and Distributions

Companies often provide employees with such ownership with no up-front costs. The company may hold the provided shares in a trust for safety and growth 𓆏until the employee retires or parts ways with the company.

Companies typically tie distributions from the plan to vesting, which gives employees rights to employer-provided assets over time. Typically, they earn an increasing proportion of shares for each year of their service.

Warning

Vesting can happen imꦉmediately, after a certain number of years (cliffಌ), or gradually over time (graded).

When a fully-vested employee retires or leaves the company, the firm “purchases” the vested shares back from them. The money goes to the employee in a lump sum or equal periodic payments, depending on the plan♈.

Once the company purchases the shares and pays the employee, the company 🍸redistributes or voids the shares. Employees who leave the company voluntarily cannot take the shares of stock with them, only the cash payment.

How to Cash Out of an ESOP

Being vested doesn’t necessarily mean you can cash out of your ESOP. Generally, it’s only possible to redeem these shares ♛if you terminate employment, retire, die, or become disabled.

Age is often an important factor. Distributions are rarely permitted to people under 59½, or 55 if they have left the company. Distributions before these ages are subject to a 10% 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS) penalty. Specific information about how to cash out of an ESOP can be found in the terms listed in the plan’s guidelines.

Fast Fact

Some ESOPs may distribute dividend payments to employees who are still at t💟he company. Other in-service distributions may be done by some p🅰lans as well.

Other Forms of Employee Ownership

Stock ownership plans provide packages that act as additional employee benefits. Other versions of employee ownership include direct-purchase programs, stock options, restricted stock, 澳洲幸运5官方开奖结果体彩网:phantom stock, and stock appreciation rights.

澳洲幸运5官方开奖结果体彩网:Direct stock purchase plan (DSPP) lets employees purchase shares of their companies with after-tax money. Some companies provide small discounts on the price of the stock as well. Tax-qualified plans are also sometimes offered.
Restricted stock gives employees the right to receive shares as a gift or a purchased item after meeting particular restrictions, such as working for a specific period or hitting specific performance targets.
Stock options provide employees the opportunity to buy shares at a fixed price during a specified time period known as the exercise window.
Phantom stock provides 澳洲幸运5官方开奖结果体彩网:cash bonuses for good performance. These bonuses equate to the value of a particular number of shares.
Stock appreciation rights compensate employees based on how much the company's stock has appreciated in a given period.

What Does ESOP Stand for?

ESOP stands for e▨mployee stock ownership plan. An ESOP grants company stock to employees, often based on the duration of their employment. Typically, it is part of a compensation package, where shares will vest over a period of time. ESOPs are designed so that employees’ motivations and interests are aligned with those of the company’s shareholders. From a management perspective, ESOPs have certain tax advantages, along with incentivizing employees to focus on company performance.

How Does an ESOP Work?

First, an ESOP is set up as a trust fund. Here, companies may place newly-issued shares, borrow money to buy company 👍shares, or fund the trust with cash to purchase company shares. Meanwhile, employees can accumulate a growing number of shares, an amount that can rise over time depe༒nding on their employment term. These shares are meant to be sold only at or after the time of retirement or employment termination. The employee is remunerated by receiving the cash value of their shares.

What Is an Example of an ESOP?

Consider an employee who has worked at a large tech𝕴 firm for five years. Under the company’s ESOP, they have the right to receive 20 shares after the first year, and 100 shares total after five years. When🥃 the employee retires, they will receive the share value in cash. Other types of stock ownership plans may be offered instead of an ESOP. They include stock options, restricted shares, and stock appreciation rights, among others.

Are ESOPs Good for Employees?

Yes, ESOPs can generally be considered a benefit for workers. These programs tend to be adopted by c🎐omp🧸anies that don’t change staff frequently. They often result in a bigger payout for employees.

The Bottom Line

ESOPs are generall⛦y a win-win for employers and employees, encouraging greater effort and commitment in exchange for bigger financial rewards. However, they are complex and can be difficult to understand.

Not all ESOPs are the same. Rules on actions such as vesting and withdrawals can vary. It’s important to be aware of them to make the most of this benefit and not potentially miss out on an extra bonus.

Article Sources

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Internal Revenue Service. “.”
U.S. House of Representatives, 🔯United States Code, Office of the Law Revision Counsel﷽. “.”

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