An Employee Stock Ownership Plan (ESOP) is most well-known as being a type of qualified employee retirement plan. But there are many more benefits of an ESOP – to both employers and employees.
At the simplest level, an ESOP is a tax-exempt trust that is set up as a defined contribution retirement benefit. ESOPs grant company stock to employees, allowing participants to save for retirement tax-free and become shareholders in the company for which they work. ESOPs are also used as a corporate finance strategy and in succession planning when an owner is considering retirement or selling the business.
Top 5 Advantages and Benefits of an ESOP
ESOPs offer advantages to business owners and their employees. There are tangible financial benefits of an ESOP, but there are also strategic business benefits and even emotional benefits to these unique trusts.
#1: Tax Advantages to Employers and Employees
There are several tax advantages for employers who offer an ESOP. Contributions made by C-Corporations are tax-deductible for the business and can be used to repay the ESOP’s loans. For S-Corporations, any portion of the stock that is owned by the ESOP company is tax-exempt.ESOPs provide a tax-free retirement savings option for plan participants as well. Contributions are made by the employer and grow tax-free until the employee receives a distribution from the account, usually after age 59 ½. Even then, a participant could choose to roll the funds over into an IRA and defer their taxes even longer.
#2: Planned Exit Strategy for Owners
ESOPs are frequently adopted by family-run businesses or by owners who started the company themselves. When the time comes for the owner to retire, they may not be happy with their options: sell to a competitor; sell to a third-party; seek out a merger and acquisition buyer; or shut the business down. Many of these owners have spent their lives building this business and want to leave a legacy, not to mention jobs for their valued employees.An ESOP is a guaranteed sale, allowing them to exit the business by selling it to the employees. Owners can create a transition plan that works for them, choosing to remain involved in the business as little or as much as they want and for as long as they want. The business remains in the community. Employees still have jobs and a retirement benefit. The owner can retire in peace knowing their business will continue to operate and they have received fair market value for their business.
#3: Corporate Finance Tool
ESOPs can be used as a corporate finance tool since these plans are allowed to borrow funds on employer credit in order to obtain employer stock. Those funds can then be reinvested in the company, used to refinance outstanding debt, or to make new purchases or acquire assets. The fact that ESOP contributions are tax-deductible means that companies can use pre-tax dollars to make principal and interest payments on the ESOP’s debt service obligations.
#4: Effective Talent and Retention Strategy
One of the biggest unsung benefits of an ESOP is in its use as a talent attraction and employee retention strategy. Today’s labor pool is more driven than ever to work for companies that demonstrate their appreciation for their employees and provide excellent benefits. Offering an ESOP as an employee benefit makes employees feel valued and rewards them for their work making it an extremely attractive employee benefit.
- Contributions and growth are tax-free until disbursement.
- There is no employee contribution required.
- Contributions are made in the form of company stock, which essentially makes employees shareholders in the company.
- Payouts increase the longer an employee stays with the company.
- Growth and profits go right back into the ESOP, which means plan participants receive more contributions.
#5: Productivity Improvements
Related to employee attraction and retention, ESOPs are productivity improvements. Employee participants become invested in the success of the business literally and figuratively when they have equity ownership. As employee-owners, participants know that their work directly impacts their retirement account. They aren’t working to benefit faceless shareholders; they are working to benefit themselves and their colleagues. This contributes to a sense of ownership and pride that employees who do not receive company stock do not feel. Morale and performance improve, teamwork increases, and trust in the company grows because everyone is sharing in the company’s success.
Is an ESOP Right for Your Company?
ESOPs are an attractive option for all of the reasons listed above and then some. They are beneficial for employers and employees and even benefit the communities in which they are located by providing stable jobs and supporting company longevity. If your business is at the point where succession planning and an exit strategy is needed, you want to provide an additional benefit to your employees, or want to explore additional corporate financing tools, it may be time to consider forming an ESOP.To find out if an ESOP is right for your business, you will need to consult an experienced ESOP attorney and/or ESOP accountant. These specialists can help you review the legal, financial, and administrative requirements that are unique to ESOPs to learn how an ESOP could impact your business.
How Aegis Can Help
Aegis Trust Company provides ESOP consultations for businesses considering an ESOP. We are further available as a Transaction Trustee and/or as an Ongoing Trustee to plan sponsors who need help managing their ESOP and complying with ERISA requirements. Learn more about our services here, or contact us to discuss your needs and how Aegis can help.