What is an ESOP?
An ESOP is a financing tool that facilitates employees obtaining an ownership stake in their company. Today, ESOPs are used by various companies, including small businesses, large corporations, as well as public and private companies.
But ESOPs are a highly complex, narrowly defined type of employee ownership plan. Learn more about the factors and benefits that help shape an ESOP.
But ESOPs are a highly complex, narrowly defined type of employee ownership plan. Learn more about the factors and benefits that help shape an ESOP.
ESOPs can take different forms, but in general, they involve a trust that is established to hold company stock on behalf of employees. Employees then become beneficiaries of the trust and, over time, typically receive more stock the longer they’re employed with the company. Since employees receive more shares the longer they stay with the company, ESOPs also tend to have lower employee turnover rates than traditional companies.
Many people are aware of the Employee Retirement Income Security Act of 1974 (ERISA) as it relates to worker protections like COBRA and HIPAA. But ERISA also included language that both defined ESOPs and assigned power to the Department of Labor (DOL) to ensure plans are structured with appropriate participation and administrated with the oversight of a fiduciary.
ERISA also established legal rights for plan participants and beneficiaries, including:
• The right to receive plan information,
• The right to sue for benefits, and
• The right to challenge plan decisions.
This language was designed to ensure that employee benefits are secure and that employees can receive the benefits they have been promised. And 50 years later, the DOL still evaluates and regulates ESOPs based on ERISA.
ERISA also established legal rights for plan participants and beneficiaries, including:
• The right to receive plan information,
• The right to sue for benefits, and
• The right to challenge plan decisions.
This language was designed to ensure that employee benefits are secure and that employees can receive the benefits they have been promised. And 50 years later, the DOL still evaluates and regulates ESOPs based on ERISA.
The core benefit of the ESOP is that it gives workers the opportunity to own a stake in the company they work for. In addition to a worker's wages and a separate 401(k) plan, having ownership in a company can give employees improved financial security and enables them to build wealth through the shared success of the company. Additionally, ESOPs can lead to increased job satisfaction, engagement, and motivation, as employees feel more invested in the success of the company. Importantly, ESOPs grant ownership to employees as a reward for their hard work, at no incremental out-of-pocket cost to the employee, and ESOP grants are not intended to replace any wages or benefits workers would otherwise receive.
According to Gallup, 66% of workers describe themselves as “not engaged” or “actively disengaged.” While this alarming figure is a top concern for many companies, ESOPs generally have more motivated and engaged workers. The shared interest in seeing the company succeed organically improves internal communications and drives employees to seek operational efficiencies that reduce costs and help the company’s overall bottom line. ESOPs also tend to have lower turnover rates and related costs as employees have a vested interest in staying with the company longer to grow their ownership share.
There are also substantial tax benefits for ESOP companies, including exemption from many federal and state taxes. Contributions made by the company to the ESOP trust are also tax-deductible. The idea is that the money saved from tax benefits can be reinvested in the company, allowing these companies to implement organizational improvements that further set up the ESOP for success, which ultimately benefits the workers and the economy.
There are also substantial tax benefits for ESOP companies, including exemption from many federal and state taxes. Contributions made by the company to the ESOP trust are also tax-deductible. The idea is that the money saved from tax benefits can be reinvested in the company, allowing these companies to implement organizational improvements that further set up the ESOP for success, which ultimately benefits the workers and the economy.