Disadvantages in an ESOP

By Steve Savant

Ash Brokerage Corporation


The employee stock ownership plan (ESOP) is essentially a stock bonus plan in which employer stock may be used for contributions. Some of the disadvantages for employees are: They will generally not produce as large of a contribution and deduction for older employees as will a defined benefit plan, and the deductible contribution limits are set at 25 percent of covered compensation. Additional issues include certain voting rights must be passed through to the participants, and ESOPs can be costly to set up with ongoing administration, which can also be expensive because of the need to have the stock value appraised each year.

Future repurchases may not come at a convenient time and must be made with after-tax dollars. This could place a financial strain on the employer. Effective July 1, 2012, if a plan gives participants the right to direct any investments, plan sponsors must provide participants with expanded, standardized investment fee and performance information. Failure to comply with these ERISA requirements may result in a breach of fiduciary duty to plan participants and the loss of ERISA Section 404(c) protection (meaning the plan fiduciaries may be held responsible for the results of the participants’ own investment choices). Steve and Keriti explore that impact with ESOPs on employees and employers.