Retirement plans can be very confusing and the rules governing them change with the tax code and with different administrations, recent years being no exception. One of the most complicated, but advantageous retirement plans if you are a fit for it, is the Employee Stock Ownership Plan or ESOP for short. According to the United States Department of Labor, as of 2016 there were 702,540 Pension Plans in the U.S., but only 6,660 of them were ESOPs according to the National Center for Employee Ownership.
ESOPs are very complicated so this will only be a high-level overview of the features of this unique plan. Retirement plan consultants and financial advisors who specialize in these plans need to be consulted in order to determine if an ESOP is good for you and your organization. These plans are generally exceptional for both the company owner and the employees if the firm is primarily owned by founders of a profitable company who want to sell their company, but are concerned about the future of their employees post-sale.
In an ESOP the founder of a profitable company essentially sells all or part of the company to the employees. The employees do not literally pay for the company, rather the company typically, but not always, borrows money from a bank to buy the stock for the plan from the founder. The companies cash flow is used to pay the new debt. The employees get a new additional retirement plan, the ESOP then contributes to them for free, stock in the company. At retirement they sell their company stock back to the ESOP plan and get cash, just like most other retirement plans.
The benefit to the employees is they get an additional, free retirement benefit in an investment they know very well, their employer. As owners of their company they now have a vested interest in the future well being of the company. Of course, an ESOP should never be the only retirement plan of anyone, moreover it should never be the majority of an employee’s nest egg, as any good financial advisor will tell you.
The benefit to the founder is that they get to sell their company and retire using the proceeds, but they know the firm will likely live on given the new owners or part owners are the employees. However, one of the most significant benefits for the founder is if they are selling at least 30% of their company to the employees, there is a roll over strategy that essentially allows them to defer capital gains taxes on the proceeds for the balance of their life. If the founder rolls over the proceeds into one of the IRS approved securities, generally publicly traded stocks and bonds, then the founder can essentially defer capital gains taxes on the sale of their company for the rest of their life. They can live off the interest or dividends, or even borrow from their brokerage account via a margin account using the underlying security as collateral.
As you can see, an ESOP is very complicated. However, the prospect for a founder to sell his or her company to retire and ensure its continuance, provide employees with ownership, and not pay capital gains taxes on the sale is compelling. It is vital to consult with expert pension consultants and financial advisors that deal in ESOPs regularly to navigate this attractive retirement plan option.