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What is an ESOP?

An ESOP, or Employee-Stock Ownership Plan, is a unique retirement plan allowing employees to own the company. Companies that opt for an ESOP will establish an ESOP Trust, where owners can sell company shares or issue new shares for the trust. Often, when owners sell their shares to the trust, a bank loan is required to generate funds to purchase the owners’ shares. Employees then get the right to the shares in the trust relative to their pay. Employees will then gain access to their shares upon retirement, which companies must buy back from the employees at fair market value. This is an excellent way for companies to incentivize employees to work hard as it will increase stock prices and, ultimately, their retirement funds. Such a unique retirement plan comes with special rules for the payout. These unique rules often raise questions for those enrolled in the ESOP plan.

Who is eligible for an ESOP Distribution?

It can be difficult to tell who is eligible for ESOP distributions as it differs significantly from most employer-sponsored retirement plans. The requirements to qualify for an ESOP distribution are one of the following:

- Retired from the company and over 59.5 years of age

- Terminated from the company or quit and over the age of 55

- Still working for the company but over the age of 70.5

A vesting period is also required for employees to become eligible for an ESOP distribution. This period differs based on the company.

How are ESOP Distributions Paid?

There are a few different ways distributions can be paid. If an employee retires, distributions begin one year after the end of the plan year. The plan year refers to the annual reporting period for the ESOP, which can create a large discrepancy in when distributions begin. If an employee quits or is terminated from the company, the distributions would start no later than six years after that date.

Distributions can be paid as a lump sum or in six equal payments over five years after qualifying. In some cases, distributions can be spread across ten years if the balance exceeds an amount specified by the IRS. Something to consider when deciding how to receive distributions is the fact that the stock price will change. If you were to choose not to take the payment in a lump sum, then the cost of the stock and, therefore, how much you receive will change in price.

ESOP distributions are taxed as regular income, but not until it is distributed. If you take a distribution before 59.5 years of age, you will be subject to early withdrawal fees. One way to avoid these fees is to roll the ESOP into another retirement account, such as an IRA. If the lump sum is taken in shares, they will be subject to capital gains taxes upon the sale of the shares on top of the regular income tax from receiving the shares. ESOPs are also subject to RMDs.

What Options Are There for The Distributions?

ESOPs are very complex, and the recommendations for what to do with them can vary depending on your financial plan and goals, so that is why we would recommend that you contact a Financial Advisor to discuss your options. One of the Financial Advisors would be happy to help and you can schedule a meeting with one of them today.

All About ESOPs (Employee Stock Ownership Plan)

November 16, 2023

David Gearhart

Whitaker-Myers Wealth Managers is an SEC-registered investment adviser firm.  The information presented is for educational purposes only and intended for a broad audience.  The information does not intend to make an offer or solicitation to sell or purchase any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed.  Whitaker-Myers Wealth Managers reasonably believes that this marketing does not include any false or misleading statements or omissions of facts regarding services, investment, or client experience. Whitaker-Myers Wealth Managers has a reasonable belief that the content will not cause an untrue or misleading implication regarding the adviser’s services, investments, or client experiences. Please refer to the firm’s ADV Part 2A for material risks disclosures.

Past performance of specific investment advice should not be relied upon without knowledge of certain circumstances of market events, the nature and timing of the investments, and relevant constraints of the investment. Whitaker-Myers Wealth Managers has presented information in a fair and balanced manner. 

Whitaker-Myers Wealth Managers is not giving tax, legal or accounting advice, consult a professional tax or legal representative if needed. 

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