Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

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Can funds from other retirement funds be used for an ESOP purchase?

It is possible to use funds from other employee retirement funds, such as 401(k) plans or profit sharing plans, to help fund an ESOP, but there are significant risks and costs. Excess funds from a defined benefit plan can be used if a defined benefit plan has more assets than it needs to pay its obligations. The plan can then be terminated and the excess goes back to the employer. There is a 50% excise tax on the reversion if the company keeps it (plus income tax), but only a 20% excise tax if it goes into an ESOP. This arrangement had been used in some prominent large ESOP in the 1980s, but not since then, and we do not recommend doing it, both for tax and employee relations concerns..

Alternatively, the employer can decide to redirect funds in a profit sharing plan or the employer or employee contributions to a 401(k) plan into the ESOP. This is a fiduciary decision subject to the requirement that assets be invested prudently. Because of this, it is not advisable to put most or all the assets into the ESOP. If the company does poorly, participants could sue the fiduciaries for making a bad investment choice. Most advisors recommend not putting more than 30% of the plan assets into an ESOP.

Alternatively, employees can be given a choice to purchase stock in the ESOP by directing funds from their 401(k) or profit sharing plan into the ESOP. This will ease fiduciary concerns provided employees are provided with detailed, objective information about the investment and its risks. Careful design of the offering to employees is a must, full financial disclosure about the offering (including risks) is required and, in some cases, registration under state and/or federal securities laws be required as well. This will add considerable cost and time to the process.

Link to this FAQ Topic: Financing an ESOP