Answers to your ESOP Questions
ESOP Information for Employees
Answers to Your ESOP Questions
If you’re an employee of a closely held company that’s considering becoming an ESOP, or you’ve recently learned that your employer is an ESOP company, you probably have questions.
We’ve created this page just for you, with answers to some of the most frequently asked questions about what ESOPs mean for employees.
ESOP stands for Employee Stock Ownership Plan; an ESOP is a federally regulated, qualified employee retirement plan that can be used as a business transition tool and a vehicle for employee ownership.
An ESOP gives employees ownership interest in the business through shares of company stock. These shares are allocated to workers annually, and their rights to the full value of their ESOP accounts increase over time (this process is known as vesting). When they leave the company, the ESOP shares are bought back from employees.
Each year, your company allocates shares, or parts of shares, to your ESOP account. The number of shares allocated to you is determined by the specifics of your ESOP rules. Every year, the ESOP goes through a valuation process in which an independent business valuation expert and an ESOP plan trustee determine the share value. Annual share value is based on company performance, profitability, and growth — so the work you do to reduce costs, boost productivity, and eliminate waste can directly contribute to increased shareholder value.
After valuation is complete, your company leadership announces the ESOP’s annual share value, and you’ll receive a statement of your ESOP account.
Eligible employees receive their vested ESOP benefits as a retirement plan distribution after they separate from employment. Distributions may be paid out as cash, stock, or a combination of both. A distribution may be a lump sum, or it can be divided into several, generally equal payments over no more than five years. ESOP companies that follow best practices have a written distribution policy that demonstrates compliance with Internal Revenue Code requirements.
An ESOP’s benefits to employees aren’t limited to the value of company shares.
In fact, studies have shown that employees of ESOP companies experience:
- 5-12% higher wages
- 2.5 times greater retirement account balances
- Lower employee turnover
- Fewer layoffs in challenging times
- Greater company stability
These advantages add up to bigger increases in wealth by ESOP employees than by their counterparts at non-ESOP companies.
In terms of the retirement benefit, ESOPs statistically outperform 401(k) plan rates of return, so they’re a strong employee benefit option. But that’s not all; ESOP companies are actually more likely to offer a 401(k) plan — in addition to the ESOP retirement benefit — than non-ESOP companies.
What’s more, where younger and/or lower-paid employees tend to participate in 401(k) plans in lower numbers, ESOPs don’t require employee contributions. So more employees get access to the retirement plan benefit.
ESOP distributions are paid out when employees leave the company. This can be in a lump sum payment or in substantially equal annual payments over a period of not more than five years. Employees meeting certain requirements for age and plan participation may choose to take limited distributions for diversification purposes before leaving the company. These diversification rights begin at age 55 for employees with 10 years or more of employment with the ESOP.
Participants not subject to required minimum distributions (RMDs) who receive ESOP distributions can choose a rollover to another qualified plan to defer taxation until the money is withdrawn in retirement.
Not all of an ESOP’s benefits are measured in dollars. The value of employee ownership often extends into the workplace culture. Many ESOPs report strong employee engagement and a culture of shared responsibility. ESOP employees learn more about what makes the company profitable, and often become more proactive in seeking ways to improve efficiency, control costs, and innovate in their industries.
Employers call this “ownership culture,” and it makes sense — when you’re a company owner, you’re invested in the health of the business!
If you’re among the millions of U.S. employee-owners, congratulations! You have access to a uniquely valuable benefit, and as an employee-owner, you have an important role to play in the productivity, efficiency, and profitability of the business.
“Thinking like an owner” means taking action when you discover ways to work better, more efficiently, faster, more safely, and/or with less waste. It can mean innovating in terms of your product or service offering to grow the business. When you have ownership stakes in the company, it can really change the way you think about work.
You may want to ask whether your company has an ESOP culture and communications committee. Many ESOP companies do, and the culture committee is often responsible for communications, events, and programming to help employees engage more effectively in ownership culture — sharing ways colleagues are “thinking like owners” to deliver even more value to shareholders (like you).
What if I have more questions about employee ownership and my ESOP?
Your human resources department can point you to specific resources and documents to answer questions about your company’s ESOP. For more information about ESOPs in general, you can also visit A Visual Guide to Employee Ownership.