Is an ESOP a Defined-Contribution Plan?

An ESOP is the most common way for employees to take ownership in an employer.

An employee stock ownership plan (ESOP) is a type of defined-contribution pension plan. The assets in an ESOP primarily consist of the stock of the employer, which is the plan sponsor. Although there is not much diversification in an ESOP retirement plan, there are some tax advantages carved out for plan members.

Identification

An ESOP gives a plan member, who is an employee, part ownership in the company for which he works. That plan member does not become eligible to receive the company stock until retirement, disablement, changing companies or death, at which time a beneficiary will receive the ESOP benefits. To fund the plan, the employee makes contributions to the ESOP via his paycheck and/or the company makes cash contributions to the plan.

Features

According to the National Center for Employee Ownership (NCEO), an ESOP is structured as a trust fund. The employer either makes cash contributions to the plan to purchase company stock or contributes shares of stock directly. In a defined-contribution plan, the employee runs the risk of having no recourse if investments lose value. In a defined-benefit plan, the employer is accountable for retirement benefits.

Characteristics

An ESOP can provide tax advantages both to the plan sponsor and employees. The sponsor's cash contributions are tax deductible up to a certain amount. Employee contributions are not taxed, according to NCEO. The value of each individual ESOP account is based on that employee's salary in addition to the number of years worked at the company and the value of the employer's stock.

Considerations

Although an ESOP plan can invest in assets outside of company stock, the primary allocation is to company stock. This could be a risky way to save for retirement. According to Business Week, when the Tribune Co. filed for bankruptcy protection in 2008, the value of the company's stock, and subsequently the ESOP were in danger of being worth next to nothing. Employees of a bankrupt company receive no special treatment compared with other stock investors.

References

• Business Week; Tribune Bankruptcy Snares Employees; Emily Thornton; December 2008
• The National Center for Employee Ownership: How an Employee Stock Ownership Plan (ESOP) Works

Resources

• The ESOP Association; Employee Ownership in the United States; Focus on the ESOP Model