• Peter Newman, CFA

Tax Strategies for ESOP Participants

Updated: May 12

An Employee Stock Ownership Plan (ESOP) is a type of retirement plan, with tax treatment similar to a 401(k) plan. ESOPs invest primarily in company stock and hold assets in a trust for employees. ESOP participants accrue shares in the plan over time. Shares are allocated to an account for each employee. Companies use ESOPs as a strategy to motivate employees to be more productive, enhance company profits, and help employees grow their nest egg. Employees get paid the value for their shares when they resign or retire from the company.

A well planned tax strategy could allow you to increase your wealth.

Tax benefits for ESOP participants are similar to those with 401k plans. Shares within the ESOP can grow tax deferred until funds are withdrawn for retirement. There are additional financial benefits for ESOP participants whose companies are doing well.


No Cost or Tax on Shares Granted

Shares are granted to employees at no cost to the employee. And, at the time ESOP shares are put in the retirement account, employees are not taxed on the value. This is similar to an employer match made to a 401(k) plan. Once in the account, the shares granted can grow tax deferred in the employee’s account. If the company does well and the value of shares increase across time, an employee may enjoy significant growth tax free until withdrawal. Withdrawal may occur during a diversification period or at retirement.



Withdrawal Windows


Diversification period: Employees who are 55 or older and have participated in the ESOP for at least 10 years are legally required to have the option of diversifying up to 25% of their ESOP account shares. Diversification happens when companies buy back employee shares in exchange for cash. This diversification option continues until age 60 at which time the participant must have the option of diversifying up to 50% of his or her shares.


Retirement or separation: ESOP plans are required to allow employees to retire at age 65, but some allow for earlier retirement. At the time an employee declares his or her retirement, most ESOPs distribute the value of remaining shares in substantially equal installments across five years beginning the plan year following your retirement date. This means distributions could start very soon or within two years depending on timing. It is important to consult with your financial advisor and human resources department to plan accordingly, especially if you are counting on distributions to fund living expenses.


Getting Paid: Anticipating Your Tax Obligations

Employees have two options when paid the value of shares. The option is usually selected on a form or website received from the company HR department or ESOP plan administrator.


1. Your employer can issue a check directly to you. When paid directly, you will have to pay tax on the value you receive. This means you will owe regular federal income tax, and possibly state tax, on the value you receive. You can spend your cash, put it in a savings account, or reinvest in a taxable brokerage account.


2. Your employer can issue a check to your 401k or IRA account. This option is known as a “rollover”. The benefit of a rollover is that the cash can be re-invested in the funds in your IRA or 401k. This allows your nest egg to continue to grow until you withdraw distributions for living expenses.


By investing in a tax deferred IRA or 401k, you can manage the tax due on your distributions each year with some planning. Your financial advisor or CPA can help you plan withdrawals each year and assist with tax bracket management. A well planned tax strategy could allow you to increase your wealth, generate sustainable retirement income, and pay a lower overall tax bill on your ESOP distributions.


What About State Income Taxes?

When you take your IRA or 401k distributions, you will be taxed on withdrawals by your state. However, if you live in one of the following eleven states, your retirement income will not be taxed:

  1. Illinois

  2. Florida

  3. Pennsylvania

  4. New Hampshire

  5. Mississippi

  6. Tennessee

  7. South Dakota

  8. Wyoming

  9. Texas

  10. Nevada

  11. Washington


Are you comfortable with your progress towards retirement?

A well planned tax strategy could allow you to increase your wealth, generate sustainable retirement income, and pay a lower overall tax bill on your ESOP distributions.


If you need help forecasting your post tax retirement income consider working with a financial advisor or your CPA. He or she can also help you address whether to take your ESOP diversification directly or roll into your IRA or 401k.


If you are uncertain with your progress towards retirement or would like a second opinion regarding diversification of your company holdings, schedule a call with me today.



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About the Author

Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.


Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance and estate planning advice, Peak Wealth Planning is a fee only financial advisor based in Champaign, Illinois.

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