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Funding plans with stock
Retirement plans covered in this educator focus on plans for small businesses. Most small businesses are privately held companies whose stock is usually held by a few shareholders, including the business owners.
In spite of being a privately held company, you can contribute shares of your stock to a deferred compensation plan you have set up for employees. Often, these stock-funded contributions are made to a 401(k) plan or other defined-contribution plan, most notably a money-purchase pension plan.
According to a 2002 survey by the Profit Sharing/401k Council of America (PSCA), 7.6% of 401(k) plan assets for companies with fewer than 5,000 participants were invested in company stock.
An employee stock ownership plan (ESOP) is commonly used to contribute company stock to your deferred compensation plan. ESOPs are set up as trust accounts. You, the employer, directly contribute shares of stock to an ESOP or the cash necessary to pay for the stock. If a departing employee decides to sell his or her shares, the ESOP steps in as a ready buyer of the shares.
According to the National Center for Employee Ownership, an estimated 9,225 companies and 10.1 million employees use an ESOP. ESOPs require that employees vest in order to receive the ownership benefits. The two main types of vesting are cliff vesting and graded vesting. The Employee Retirement Income and Security Act (ERISA) of 1974 governs the use of ESOPs.
If you choose to set up a defined benefit plan, you are generally limited to investing no more than 10% of the plan's assets in shares of your stock. ESOPs -- which use individual retirement accounts -- are generally exempt from this investment limit.
(Note: The downside, of course, is that your deferred compensation plan may be overly concentrated in shares of your company stock. Financial planners often warn against over-concentration of retirement assets, instead favoring the benefits of a diversified portfolio.)
An ESOP is often used in conjunction with a traditional 401(k) plan for funding contributions. Contribution limits to a defined-contribution plan generally govern how much stock can be contributed to an individual's 401(k) account. For 2007, you and the employee can contribute up to a lesser, combined amount of $45,000 or 100% of the participant's compensation.
Similar to other retirement plans, the value of stock or cash that you, the employer, contribute to an ESOP is tax-deductible. Deductibility of ESOP contributions may be limited in some cases. Your plan administrator should help you calculate the amount that you can deduct.
For more information on administering ESOPs, see the Web site of the National Center for Employee Ownership (NCEO).
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.
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