Managing ESOP Distributions

Employee Stock Ownership Plans (ESOPs) stand as an innovative approach for companies to empower their workforce by offering a pathway to retirement benefits through beneficial ownership stake. However, the mechanisms governing ESOP distributions are intricate, requiring a clear understanding by plan administrators and employees alike. Additionally, the distribution provisions should be reviewed every three to five years to make sure they still fit the needs of the company and the ESOP plan. Here, Dan Markowitz, CPA, Boulay ESOP advisory leader, explains ESOP distributions and how the put option impacts repurchase obligation.

Navigating Distribution Timelines and Scenarios

Distributions must begin within the predetermined timelines governed by the Internal Revenue Service. Separation from service triggers the timing of distributions, which can start within one to five years of separation of service, depending on the type of separation. Once the waiting period is met, annual installments of the balance must be made over a one to five year period. Exceptions exist for large account balances, which can be stretched up to another five years.

Various scenarios, such as resignation, retirement, or death, impact distribution timelines. Additionally, the plan sponsor has the choice of offering stock or cash distributions, depending on specific conditions, ensuring equitable treatment among employees. An employer is largely unable to defer or lengthen the distribution period pass the five year wait period and five annual installments, limiting their ability to shift their repurchase obligation into the future. The law also requires highly compensated employees (HCEs) and other ESOP participants to be treated fairly and not to discriminate against HCE employees. Consult a retirement plan professional for details regarding the anti-discrimination rules and the impacts it has on ESOP distributions.

Understanding the Put Option and Valuation

For closely held companies, the concept of a put option must be considered. If the company chooses to offer stock distributions to the participants, it comes with an automatic put option. The put option mandates the repurchase of shares from departing employees by the company, creating a market for the company’s stocks. The put option is important because it does not allow terminated participants to hold shares that are distributed by the company. Understanding the impact of the redemption of shares subject to the automatic put option of the share price in the short and long term is essential.

Complexities and Experience in ESOP Management

Handling ESOP distributions remains a complex task, often requiring the assistance of experienced ESOP advisors or legal consultation due to the intricacies of plan administration under ERISA requirements. The nuances in distribution timelines, valuation, and put option execution necessitate professional guidance to ensure compliance and fairness.  This decision should also be viewed together with the other strategic initiatives of the company to make sure there is not any unintended consequences. To understand the impact of the distribution policy on the company’s financials, the company should perform an ESOP sustainability study in conjunction with the review of their distribution policy.

Helping You Get There…

Seeking expertise in ESOP administration and consulting becomes a requirement for organizations looking to provide robust retirement benefits through employee ownership. Contact a member of the Boulay ESOP advisory team today to learn how we’re committed to helping you get there.