As companies make annual contributions to an ESOP over time, shares held as collateral against the outstanding balance of the ESOP’s loan are released to participants. The allocation of shares to participant accounts is based on the formula dictated in the ESOP’s plan document. The plan document also governs eligibility for employee participation in the ESOP, vesting requirements, diversification rights, and the company’s distribution policies upon an employee’s retirement, death, disability, and employment termination.
In general, when an ESOP participant is eligible for a distribution payment, the company, or the ESOP, will repurchase that person’s vested shares in exchange for a lump sum payment or installment payments over a period of years. The value of the vested shares is established annually by the ESOP’s trustee with the assistance of an independent valuation advisor.
When will you receive funds?
Provisions in the ESOP plan document will stipulate when payments will be made based on the event forcing a distribution. In other words, a participant eligible for a distribution due to death or disability may receive funds during the next distribution period, whereas a participant eligible for a distribution due to non-retirement employment termination may be subject to a waiting period.
An ESOP participant can elect to receive their distribution payment in cash (and pay ordinary income taxes), or have the proceeds rolled over directly into another qualified retirement plan (e.g., a traditional IRA, or another company’s 401(k) plan). Funds rolled over into another qualified retirement plan continue to grow tax deferred. Taxes would be due and payable at ordinary income tax rates at the time of the eventual funds withdrawal from the qualified retirement plan holding the assets.