ESOP Terminology
Allocation: Each year the ESOP puts assets (typically in the form of stock or cash) into individual accounts of participants that meet the eligibility requirements. Your portion of the contribution is called an allocation. The size of a participant’s allocation is determined based on the plan’s allocation formula.
Annual Valuation: Every year the ESOP shares are valued by a valuation expert to determine the value of the stock at that time. That value will determine the amount of money in your ESOP retirement account.
Contribution: The company can make a cash deposit, or a contribution, into the ESOP, which can then be used to buy back shares, repay a loan, or build up a cash reserve in the ESOP for future use. Contributions into the ESOP are tax deductible.
Distribution: Companies have different rules about how accounts are paid out after you leave the company, also known as your distribution.
Diversification: As an ESOP participant, your retirement benefits are dependent on the value of the stock in your employer’s company. However, as you approach retirement age, you will have options to invest in other stock. All of this will be explained when you reach that age.
Eligibility: This refers to the minimum requirements which must be met before an employee becomes an ESOP participant. To get into the plan, you need to meet the company requirements for hours of service, length of employment, and age. The standard rules are 1000 hours of service, one year of employment, and 21 years of age.
ERISA: The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans.
ESOP: Employee Stock Ownership Plan is both a business ownership structure and a qualified retirement plan which enables the employees of the company to own stock through a trust.
ESOP Trustee: An ESOP trustee represents the participants in the negotiation to sell the company to the ESOP, and manages annual valuations and other duties, taking care of all the work and oversight of the ESOP on behalf of the participants.
Forfeitures: If an employee leaves prior to becoming 100% vested, the employee will keep whatever percentage of the account they have earned and the rest of the account balance is redistributed to everyone else. These redistributed shares are called forfeitures.
Participant: An employee who, by the terms of the plan, is eligible to receive the benefits of an ESOP.
Plan Documents: The Plan is the document that defines the terms of your ESOP retirement plan and includes rules for participation and receipt of benefits. Most plans are similar, but every company has some options for the terms of their plan.
Qualified Retirement Plan: This is a plan which can fund all or part of living expenses after you retire. There is a federal law known as ERISA which defines most retirement plans, participant rights and protections. An ESOP is a type of qualified retirement plan.
Repurchase: When you retire or leave the company, your stock will be purchased by the company and the proceeds of that purchase are yours to invest or add to another retirement account. You cannot continue to be an ESOP participant after you retire.
Share Value: Every year the value of your employer as a company is valued by professionals experienced in this activity. The value of any company, and the value of the shares, can go up and down. Generally, payment of debt increases the value of shares, just like the equity in a house goes up as your mortgage goes down. The success or lack of success of the company also directly affects share value.
Statement: Every year after your ESOP is established, the shares of the corporation are valued. As a participant you receive a statement of the value of individual shares. The value times the shares in your account represent the value of your retirement account.
TPA: Third Party Administrator. The TPA determines who is an eligible participant for a plan, and how many shares they have earned. The TPA also determines whose shares will be repurchased upon retirement or other events, and make sure that payment for those shares is paid to the appropriate person in the right amount.
Vesting: As you work for the company, you get an increasing right to what is in your account (a process called “vesting”). By law, this process can take no more than six years.