An employee stock ownership plan (ESOP) is a type of retirement plan which a company may make available to its employees. Participants in the plan are not taxed until they receive benefits from the plan, and a company may be eligible for certain financial incentives such as reduced tax rates in return for establishing the plan. This type of plan is viewed as beneficial because it acts as an incentive to employees, encouraging them to engage in activities which will make their companies do well because they will directly benefit when their companies prosper.
In an employee stock ownership plan, a company establishes a trust on behalf of employees. The trust is filled with stock in the company, or with cash which can be used to buy stock. Over a period of time, every employee in the company receives a vested interest in the trust, with the amount of the interest being based on seniority and compensation. As a general rule, employees must be fully vested within six years.
When an employee leaves the company, the employee is given his or her vested share in the trust, which the company can then buy back at market value. At this time, the employee will be taxed, as he or she will be receiving income. The employee stock ownership plan is not intended to act as a sole source of retirement income, as it is important to diversify retirement investments for financial security, but it can be an important part of a retirement plan.
This type of plan is not the same thing as an employee stock option plan. In this type of plan, employees can actually hold stock in their company, rather than having stock held for them in trust, and they can exercise the right to buy additional stock or to sell their stock. Stock option plans allow employees to receive stocks as benefits or compensation, and they work differently from an ESOP.
Employers can use an employee stock ownership plan to raise funds, borrowing from a lender to fill the trust. Employees with a vested interest in an employee stock ownership plan are also allowed to vote their shares, having an impact on the direction and policies of the company. Studies seem to suggest that companies which provide this option for their employees can do better as a result of more employee motivation, and that employees with access to such plans tend to save more money for retirement.