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Employee Stock-Ownership Plans (ESOP)


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An Employee-Stock Ownership Plan, usually referred to as an ESOP (pronounced "e-sop"), is a defined-contribution retirement plan in which your employer contributes shares of stock of the company for which you work. You may also be able to purchase additional shares for the account using money deducted from your paycheck.

There are limits on the amount your employer and you can invest in an ESOP.

  • Some ESOPs allow you to contribute funds to purchase company stock. Employers often match these contributions. For example, for every dollar you contribute to buy company stock, your employer might contribute 10 cents, 50 cents or even a dollar.
  • There is a maximum you can contribute per year as well as a maximum that you and your employer together can contribute to an ESOP on your behalf.  The amount is adjusted for inflation each year.

Borrowing from an ESOP is not allowed.

Taking a distribution before retirement, is generally not allowed by employers although some plans do allow it. Check with your plan administrator or benefits office. (If you do get an early distribution in cash, and are under age 59 l/2, your distribution will be subject to income tax plus a 10% penalty for early distribution of the funds. If you are over age 59 l/2, you will only have to pay taxes on the distribution).

If you become disabled as defined by your Plan:

  • Your account usually becomes fully vested. However, your distribution might not begin for as long as one year form the date of your disability.
  • The value of your stock for tax purposes will be determined as of the date you leave the company.
  • If you are considering applying for a withdrawal due to disability see: How To Apply For A Withdrawal Due To Disability

Diversification: By law, once you reach age 55 and have at least 10 years of service, your plan must let you diversify at least 25% of your account into other investments. You must be given at least three investment choices. When you reach age 60, you must be allowed to diversify at least 50% of your assets. Consider taking advantage of the diversification. The value of your retirement account could have a significant downturn if the company stock suffers a decline. With diversification, you can reduce the risk - especially if you invest in industries that tend to go up if your industry goes down. Diversification is especially important if you believe you may be accessing these moneys in the near future.

If you leave the company before you retire, you may be able to take the vested portion of the funds with you, although the Plan may require passage of a period of time before payout starts.

  • If you leave your employer before you retire, you will retain ownership of the vested amount of your account. (The "vested amount" is the amount that belongs to you no matter what). However, the plan can hold the account until you attain retirement age under the Plan.
  • When the payout begins, you may have the option of taking either stock or cash.
  • You will also have the option to rollover your account to an IRA or transfer the ESOP directly to another retirement plan. There are special tax rules for stock distributions. It is advisable to speak to a financial advisor before rolling stock to an IRA.

On retirement, there may be a delay before you receive the funds. There are usually payout options for receiving the stock/money.

  • If you retire, you will receive your ESOP account value within one year of the date of your retirement, either in stock or the cash equivalent - unless the stock in the plan was purchased by a loan that is still in repayment status.
  • You can choose one of the following options:
    • Receive a lump-sum distribution (the entire value at once) and pay ordinary income taxes on the distribution  or rollover the distribution into an IRA account OR
    • If allowed by the plan, you may also have the option of having your ESOP paid to you over time. This alternative minimizes the amount of taxes each year. If you choose this option, the amount of money you receive is based on the value of your account when you retire, regardless of any future growth or loss in the price of the stock. OR
    • You can roll over the distribution into an IRA account. Rolling the funds into an IRA allows you to earn additional growth on the value tax free while in the account. Of course, always keep in mind that stocks can decrease in value.
  • To help decide which is the best option for you, it is advisable to consult with a financial advisor such as a Financial Planner. (To learn how to choose a financial planner, click here.)

Tax on distribution: On distribution, the value of your stock is taxed as ordinary income. If you continue to hold the stock and it goes up in value, the increase in value is taxed at capital gain tax rates when you sell.

If you die:

  • Your ESOP account will usually become fully vested and will be distributed to your beneficiary.  However, there may be a delay of up to five years  before distributions begin. The delay may be even longer if the stock in the plan was purchased using a loan that is still in repayment status.
  • If your spouse is your beneficiary, he or she may avoid paying immediate tax by rolling over the proceeds into his or her own IRA.  Other beneficiaries must pay ordinary income taxes on the distribution. (For information about IRA rollovers, click here.)

For information about:

  • ESOPs and taxes, click here.
  • How To Apply For A Withdrawal For Disability, click here
  • How To Apply For A Withdrawal For Hardship, click here.

NOTE: If you have an ESOP, be sure your beneficiary designation is up to date.

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