Retirement Planning and Employee Benefits for Financial Planners

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Retirement Planning and Employee Benefits for Financial Planners

Chapter 6: Stock Bonus Plans and Employee Stock Ownership Plans

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© 2007 ME™ - Your Money Education Resource™

Stock Bonus Plans

Defined contribution profit sharing plans. Employers contribute stock to the plan. Contributions are discretionary, but must

be substantial and recurring. Allocations to the plan must be

nondiscriminatory. “Gravy”, not all I’ve got…

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Special Requirements

Participants must have: Pass through voting rights of stock, The right to demand employer securities when

taking distributions, A put option to the employer, Distributions that begin within one year of

normal retirement, death or disability, or within five years for other modes of employment termination, and

Distributions that are paid within five years of commencement of distributions.

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Advantages and Disadvantages of Stock Bonus Plans

Advantages Value of the employer stock contributed is tax-

deductible for the employer. Gives participants vested interest in performance of

company. Disadvantages

Employee has the risk of a non-diversified portfolio. Put option could create cash flow problems for

employer. Employer incurs valuation costs at contribution of

stock.

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Stock Bonus Plans

Contributions: Plan must be established by year-end Contributions must be made by due date

of return Discretionary but substantial and recurring 25% of compensation; $260,000 covered in

2014

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Stock Bonus Plans Eligibility: age 21/one year of service Allocation: typically based on compensation Vesting: 3 year cliff; 2-6 year graduated Investment: initially all employer stock

All participants can diversify their contributions/earnings

Participants with > 3 YOS can diversify employer contributions/earnings

Implications for NUA treatment

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Stock Bonus Plans

Distributions: Lump sum: Net Unrealized Appreciation

not taxed until employer stock sold Then taxed as long-term capital gain (lower

tax rates) Value of original employer contributions

taxed as ordinary income as soon as stock is distributed from plan

Installments: all taxed as ordinary income

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Employee Stock Ownership Plans (ESOPs)

Defined Contribution Profit Sharing Plan Established as a trust.

Participant receives allocations of the employer stock from the ESOP.

Employer receives a tax deduction for the value of the stock contributed to the plan.

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Leveraged ESOP (1 of 2)

BANKLender

Distributions toEmployees

ESOPTrust

PrincipalStockholder(s)

Company

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22

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3

4

2

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Leveraged ESOP (2 of 2)

1. Bank loans funds to ESOP Trust (with company’s guarantee) to purchase shares from the stockholders.

2. ESOP buys stock from the existing stockholder(s) who generally also guarantee the loan.

3. Company contributes annually (tax deductible) to the ESOP Trust, and the ESOP Trust repays the bank both principal and interest.

4. Employees receive distributions of the company stock when they retire or terminate employment with the company.

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Advantages of ESOPs Owner

Diversify holdings Replace with domestic stocks/bonds in 1 year

Creates market for stock Company

Can deduct contributions of stock Loyal, motivated employees

Employees NUA treatment Available put option:60 days after distribution Diversification: age 55/10 YOS: 25%; one year

prior to retirement age: additional 25%

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Disadvantages of ESOPs

Owner Dilutes ownership

Company Expensive administrative costs Conflict of interest issues Put option impact on cash flow

Employee Lack of diversification

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Contributions to ESOPs (1 of 2)

Deduction for the value of the stock or the cash at the date of the contribution.

Cash ESOP uses to purchase employer stock, or ESOP uses to pay bank debt.

Stock Subject to 25% of employer covered

compensation limit Leveraged ESOP – interest also deductible Interest can be added to 25% limit

Dividends paid are deductible

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Distributions from ESOPs (1 of 2)

Subject to RMD rules Lump sum of company stock

Tax when sell company stock Substantially equal periodic payment

requirement Ordinary income! If participant elects, he may demand equal

distributions from the ESOP for a period no longer than 5 years Up to 10 years if account is valued at more

than $1,035,000 for 2014

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ESOP Trustee Holds ESOP assets in trust for the benefit of the plan

participants. Held to standard of fiduciary:

Must operate with the care, skill, prudence, and diligence of a prudent man

Must act in best interest of plan beneficiaries. Plan participants and their beneficiaries Otherwise, resign and appoint neutral trustee

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Retirement Planning and Employee Benefits for Financial Planners