Establishing an ESOP with Accuplan
With over 25 years of being a premier self-directed IRA provider, we have offered alternative products and tools for our clients to utilize from our conception. Among these products is an Employee Stock Ownership Plan, also known as an ESOP, or what Accuplan calls a ‘MYSOP’ (My Sponsored Ownership Plan). Its purpose is to bring our clients more options in alternatives.
What is an ESOP/MYSOP?
This account type is called a Defined Contribution Plan, and it compares to a 401K, but is more complex. An employer will set up a trust fund where the goal is to share their private stock or designate cash to buy existing shares, all within a tax-advantaged IRA. This type of account enables employees an opportunity to buy into their employer’s shares, and in turn, brings usable capital.
These shares are issued to select employees. It is up to each company to choose how those shares are allocated.
Like other employer-sponsored benefits, employees who have shares within the company are not considered fully vested until seniority has been attained within that company. If a vested employee does leave that company, their employer must buy back the vested stock at a fair market price.
Eligible ESOP participants don’t pay taxes on the stock within their account until distributions are taken at retirement age. ESOP are taxed upon an employee taking distributions.
Distributions taken by the employees under age 59½ are considered early withdrawals and would be subject to IRS mandated taxes, along with an early penalty tax of 10%. Upon the participating employee’s death or disability, their shares within the ESOP would not be subject to the 10% penalty.
The 10% penalty can be circumvented by participants opting to roll over their ESOP contributions into another tax-sheltered account like a Traditional or Roth IRA, either with a new employer or done as an individual. This is done strategically, so the account holder incurs no income or capital gains taxes. Rolled over ESOP funds would then become subject to the set rules of the new retirement plan.
If the ESOP pays dividends to the plan participants, those funds are not subject to the 10% early withdrawal penalty tax. ESOP dividends are also absolved from income tax withholding. Note that dividend payments are taxed at a total rate.
If the ESOP were written to distribute shares of company stock rather than paying out from the value of the shares in cash, employees would pay income tax at ordinary tax rates that are based on the value of the company contribution to the plan, plus capital gains tax on the total appreciation in share value when they choose to sell their shares.
When plan participants receive distributions of $10 or more, the trustee of the ESOP or third-party administrator (known as a TPA) is required to prepare and submit Forms 1099-R and 945 for ESOP taxation reporting.
ESOP and MYSOP Rollover Rules
MYSOP distributions can be rolled over into another type of tax-sheltered retirement plan. Still, it’s important to note that the rules for distributions will vary from company to company as they see fit. Just the same as with a more traditional employer-sponsored retirement plan, there are IRS stipulated penalties for taking distributions before the proper retirement age is met.
Each company can determine whether its MYSOP distributions are made through stocks, cash, or a combination of both. No matter what method is chosen, the employee retains the option of cashing in their stocks.
Suppose an employee decides to roll over their funds into a retirement account like a traditional self-directed IRA. In that case, those funds won’t be subject to taxes until withdrawn upon retirement and will only be taxed as ordinary income.
2022 contribution limits to the account, on the employee’s behalf, is limited to $58,000 annually, or 100% of compensation.
Upon eligibility of receiving distributions from retirement plans, the employee has the right to take benefits in employer stocks, with some exceptions. The right to receive employer stocks does not extend to the portion of the employee’s account that they elected to have reinvested under the diversification rules.
Employees who take a lump-sum distribution of their ESOP account in the form of employer stock may enable deferring further taxation of the value of that stock until they sell it at a later date.
Frequently Asked Questions
If an employer terminates an ESOP, the employees have a couple of options. First, they can roll over shares into a self-directed IRA where they can continue to contribute and invest. Alternatively, there’s an option to take cash distributions from the dissolved ESOP.
Assets within an ESOP are generally company stock or cash, and they’re held in a specialty trust established for the ESOP.
Just as with traditional stockholders, ESOP participants share no personal liability for the debts within the company.