An interesting form of profit-sharing is the Employee Stock Ownership Plan (ESOP). This is a trust set up by a company to make annual contributions in stock or in cash for the trust to buy the stock. Each individual employee has their own account within the trust to hold the contributions.
Most often these contributions are made based on a percentage of compensation. Like stock option plans, the employee's shares must vest prior to receiving them. A minimum 20 percent must vest annually. Firms can allow shares to vest immediately if they wish. Employees receive all vested shares upon retirement, death, disability or termination and payments can be made all at once or in installments. That is up to the employee.
Employee Stock Ownership Plans have some interesting wrinkles to them. For instance, if you've been in the plan for at least ten years when you hit age 55, you have the option of diversifying 25 percent of your holdings into an asset other than company stock. This option remains available until age 60. At that time, the employee receives a one-time option to diversify 50 percent of their holdings in assets other than company stock.
Another interesting feature is the option to create a leveraged Employee Stock Ownership Plan. In this situation, the company or the plan borrows from a qualified lender to buy shares in the company. These shares are then deposited in the ESOP trust. Some lenders require the company to guarantee that they will make contributions to the trust and others require that the company borrow the funds directly and then loan them back to the trust. Either way, the company is using its credit worthiness to partially fund an employee's retirement.
Leveraged plans do much more than reward employees with company stock. They are used to buy out retiring owners, make acquisitions, spin off redundant assets, buy back publicly traded stock, and for many other corporate purposes. One of the more popular uses of the ESOP allows retiring owners to sell their stock to the plan tax-free as long as they reinvest the proceeds within 15 months in the securities of domestically operating corporations. This allows retiring owners to diversify their holdings without paying any immediate taxes.
In addition to being an extremely flexible investment vehicle, ESOPs also provide tax benefits to the company. For instance, if a company repays an ESOP loan, it gets to deduct both the principal and interest from its taxes, lowering the pre-tax dollars needed to repay the loan. Second, dividends paid into an ESOP are tax deductible, unlike regular dividends that are paid in after-tax dollars. This increases the funds available to the plan, which further benefits the employee.
Another way for employees to buy company stock is through an Employee Stock Purchase Plan (ESPP). This gives employees the opportunity to buy company stock at a discount to the market price, often as high as 15 percent. The contributions use after-tax dollars and any capital gains will be fully taxed. For anyone already thinking about investing in their company stock, this is an excellent way to do so for less.