What is an ESOP?
ESOPs may be a little scary for some people so let’s start with a definition.
An ESOP is a qualified defined contribution retirement plan.
It has two features that make it unique from other qualified retirement plans (such as 401(k), profit sharing, or defined benefit plans):
- It is invested primarily in the stock of the sponsoring corporation
- It can borrow money
These two unique features would be prohibited transactions in other retirement plans. Yet, these are the very features that can make an ESOP a powerful diversification or succession planning approach for many business owners. How an ESOP can diversify a business will be explained in later blogs.
What are some benefits of an ESOP over other qualified retirement plans?
An ESOP allows the owner of a C or S corporation to sell all or part of their company to an ESOP trust on behalf of their employees. The business owner can control:
- The timing and extent of his or her exit from the company
- The day-to-day operation of the company
The unique tax treatment of ESOPs helps fund the sale of the company (more on that in future blogs).
An ESOP has benefits to the company owner, the company, and the employees. Yet few understand these plans and how to take advantage of their unique features.
An ESOP is not a good fit for every business owner or company. An ESOP may not be the best choice if:
(1) The company is too small. In general the value of the business should be at least $5 to $7 million and should have 30 or more employees.
(2) The business is facing challenges with its business model or markets.
(3) The business owner does not distinguish between company and personal finances.
Several times a month I will be offering insight into ESOPs on this blog. I have worked in employee benefits for 25 years including retirement, healthcare and ancillary benefits. I spend a great deal of time talking to business owners and their advisors to learn what is important to them.
In addition to blogging here, I also tweet regularly about topics of interest to ESOPs. Follow me: @jlripperger.
Please share your thoughts in the comment section below. I read and respond to comments. So let me help!Affiliation DisclosuresCompany stock is not a pooled investment. Stock may experience greater volatility and should not be directly compared to investment options that have a more diversified investment mix. It is not intended to serve as a complete investment program by itself.
Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.