Benefits, Compensation

What Are the Benefits of Offering an ESOP?

Nearly all of us have at least heard of Employee Stock Ownership Plans—also known as ESOPs—but far fewer are sure exactly how they work and why organizations would want to offer them.

Watkins-Ross, a consulting, actuarial and administration firm, consults with employers about ESOPS, but also offers one to its employees. In this contributed piece, Rachel Perkins, MBA, and Corporate Controller at Watkins Ross, explains what ESOPS are, how they work, the advantages for employers, and how having one has benefited Watkins Ross employees.

What Is an ESOP and How Does It Work?

An employee stock ownership plan (ESOP) is a qualified, defined contribution benefit plan that invests primarily in company stock of the employer.  While many of the normal qualified plan rules apply, an ESOP’s unique plan provisions and leveraging capabilities requires specialized consulting and administrative expertise.

Providing direct ownership opportunities to your employees through an ESOP encourages motivation, retention, and may provide major tax incentives to the selling stockholders and the corporation. Employer contributions are allocated to participants’ accounts, vested and available for distribution.

The ESOP generally must distribute the benefits in the form of employer stock, at the election of the participants as they become entitled to distributions.  To facilitate such distributions, the employer may contribute the stock directly to the plan or it may contribute cash for the plan to use to purchase the stock.

What Are the Advantages to Employers of Establishing an ESOP?

There are tax advantages for both C corporations and S corporations that sponsor ESOPs.  Either type of corporation may claim a deduction of up to 25% of eligible participant compensation for contributions used to repay the principal on an ESOP acquisition loan.  In addition, C corporations can deduct the interest on the ESOP acquisition loan without it counting against the 25% they are allowed to deduct on the principal payment.

S corporations that own ESOP stock do not have to pay federal income tax on the portion of the stock owned by the ESOP.  For example, if an S corporation owns 50% of an ESOP, they do not have to pay federal income tax on 50% of the income; a 100% ESOP owned S corporation doesn’t have to pay federal income tax.  As such, ESOP companies can have competitive advantages over the competition.

How Does an ESOP Benefit Watkins Ross’s Employees?

Watkins Ross started an ESOP plan in 1988.   The owners of the company were looking to retire: Instead of selling the company to an outside firm, they wanted to preserve the legacy of the company by selling it to the people that helped build it—their employees.

The ESOP is one of the many benefits Watkins Ross provides for their employees.  This benefit stands out because not many companies give their employees a sense of ownership in the company they work for.

The employee owning the stock does not have to pay tax on the gains until they cash out the stock.  This stock can be sold to the company for cash that would be either taken as a taxable distribution or rolled over into another tax deferred investment such as a traditional IRA or a 401 (K) plan.

The ESOP benefit provides the employees with additional retirement income when they are ready to retire. The funds from the sale of the stock are funds employees wouldn’t have if this benefit wasn’t in place.

An ESOP plan motivates the employees to strive to do their best because they know the success of Watkins Ross is also their success.  Having an ESOP plan has created an ownership culture.  Each employee provides great customer service and in return the company continues to be profitable.

Rachel Perkins, MBA, has been the Controller for Watkins Ross, since 2015.  She received her MBA in Business Administration from Davenport University.

Watkins Ross is a 100% employee-owned consulting, actuarial and administrative firm providing services for employer or union sponsored retirement benefit and health plans. It serves approximately 700 clients including one-person professional service corporations, multi-employer plans, and group health plans covering thousands of plan participants.