Whether new to ESOPs or a long-time employee owner, you sometimes have questions about certain aspects of your plan. Discussion around ESOP distributions is often popular since the details and triggers can cause some confusion. Also, benefits payout can directly impact financial planning for the future, so knowing the details about ESOP distributions is essential for plan participants.
It’s not always easy to know where to look for information, so we compiled a list of 10 common ESOP questions and answers that address distributions to give you a helpful resource to use as the need arises.
1. What’s meant by “ESOP distribution”?
“ESOP distribution” refers to ESOP benefits payout to plan participants who reach a certain age, retire, resign, or otherwise separate from the company. Each plan has specific rules around what triggers payout.
2. How soon do I get paid?
The timing of benefit payout depends on why you are no longer with the company. If you’re retiring, and in the case of death or permanent disability, distributions start at the end of the plan year following the plan year during which the qualifying event happened. If you leave for other reasons, distributions are required to begin by the end of the sixth plan year following the plan year during which you left.
3. What is vesting? Does it impact my payout?
Shares are typically allocated to employee owner accounts over time of service with the company — known as vesting — and only those participants who reach the threshold number of years to be considered “fully vested” earn 100% payout. Employees who leave the company prior to being fully vested are entitled to a percentage of the payout equivalent to where they fall on the vesting schedule.
4. What is a Required Minimum Distribution?
Required Minimum Distribution (RMD) refers to the minimum amount you are required to withdraw from your ESOP account once you attain a certain age. For those born before July 1, 1949, that age is 70-1/2. For those born after June 30, 1949, the trigger age is 72 years. RMDs must be taken starting no later than April 1 of the year following the year when you turn the applicable age or retire, whichever is later.
5. I’m still working. Can I take ESOP distributions?
Whether an active employee is entitled to receive a distribution depends on the provisions of the Plan Document. While the law may allow for employers to offer distributions to active employees in certain circumstances, such as in the case of hardship, it is typically the employer’s discretion as to whether or not to adopt such provisions. You should refer to your Summary Plan Description as to whether or not your ESOP offers these unique distribution opportunities. There are two circumstances in which an ESOP must offer a distribution to its employees:
Diversification – once you have attained age 55 and completed 10 years of participation (defined by the Plan Document), your employer must offer you the opportunity to diversify a portion of your accumulated stock balance. This is known as “diversification.”
Required Minimum Distributions (RMDs) – employees who are “5% owners” and attain the minimum age requirement (currently 73) must begin receiving “Required Minimum Distributions” from the Plan. A “5% owner” is an individual who owns more than 5% of the company, either directly or through attribution from certain family members and stock rights.
6. How is the value of my ESOP distribution determined?
For distribution purposes, there are two factors that go into the calculation. The first is the total number of shares allocated to your ESOP account. The second is the appraised fair market value of the shares when distribution starts. In an ESOP, fair market value is based on an annual valuation conducted by an independent appraiser.
7. Do I have a choice in how I receive my distribution?
The type(s) of cash payouts available are determined by the provisions of the Plan Document, and the plan payout option the company chose.
8. How are ESOP distributions taxed?
ESOP distributions are taxed as ordinary income. Exceptions include rollovers to an Individual Retirement Account (IRA) in which case taxes are deferred, or you may be penalized for early withdrawal if taking distributions before the age of 59-1/2,
9. I’ve heard about ESOP distributions being paid in company stock. Is that true?
Whether your company must offer you a stock distribution depends on the Company’s filing status for federal income taxes, and whether their bylaws restrict stock ownership to active employees. Generally, a company that files taxes as a “C Corporation” must offer the opportunity for employees to elect to receive their distribution “in kind” or in cash, unless their corporate bylaws restrict ownership. An “S-Corporation” is not required to offer distributions “in kind,” but may offer employees the opportunity to receive their distribution in stock. A stock distribution from an S Corporation is usually subject to an “automatic put,” where the employee agrees to automatically sell the stock back to the company for cash; the end result is that the employee still receives cash.
Whether your distribution is paid “in cash” or “in stock” will impact how income taxes are withheld from your distribution. Where a distribution “in cash” is subject to income tax withholding if not rolled over, a distribution paid “in stock” will often not have income taxes withheld. This means that you may be responsible for paying additional income taxes when filing your income tax return.
10. Can I sell my ESOP shares?
ESOP shares are held in the ESOP trust and are not traded publicly.
ESOP distributions are just one of many topics that employee owners should explore to understand and make the most of their ESOP plan participation. Subscribe to our One-Stop ESOP Blog to stay current on news, trends, and timely topics.
