In an employee stock ownership plan (ESOP), employees buy stock in their company through payroll withholding or some other method, or the corporation contributes shares of its stock to funds that allocate the shares to employees based on their annual compensation.
Advantages. The advantage to employees is that they acquire stock of the company they work for at either no cost or reduced cost. Employees owe taxes on the value of the stock only when it is distributed to them. In the meantime, the stock can appreciate tax-free. And when employees take possession of the stock, they can continue the tax-favored treatment by rolling it over into an IRA.
Drawbacks. Because all or most of your stake is invested in one company, you lose the protection of a diversified investment portfolio. And because you are already counting on the company to provide you with your preretirement income, you should think twice about whether you want to depend on its stock price to provide your income in retirement as well.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Some profit-sharing plans pay the money directly to employees each year in the form of cash, meaning employees owe taxes on it, and it's up to them to decide how to invest it (or spend it).
Most plans, though, defer the payout until you leave the company, directing the money into an account that grows year by year.
You owe no tax until you withdraw the money, which is usually invested in the meantime by professional investment counselors under the supervision of the plan trustees or an investment committee. A small percentage of profit-sharing plans give employees a voice in the selection of investments.
Some plans invest part of their funds in the company's own stock. That can prove an advantage or disadvantage to the employee, depending on the company's dividend-payment policy (if the stock held by the plan earns dividends), and on whether the stock appreciates or declines in value as the years go by.
Although they lack the guarantees of regular pension plans, profit-sharing programs make it possible to accumulate sizable retirement funds when you work a long time for a successful company. Many plans are offered in combination with other retirement plans. The ideal arrangement would be a program that combined a defined-benefit pension plan with deferred profit sharing.
-
Stock Market Today: Have We Seen the Bottom for Stocks?Solid first-quarter earnings suggest fundamentals remain solid, and recent price action is encouraging too.
-
Is the GOP Secretly Planning to Raise Taxes on the Rich?Tax Reform As high-stakes tax reform talks resume on Capitol Hill, questions are swirling about what Republicans and President Trump will do.
-
Understanding Capital Gains and Lossescapital gains tax What's a capital asset, and how much tax do I have to pay when I sell?
-
Know the Rules of Your 401(k)401(k)s There are all sorts of regulations controlling how money goes in and comes out of a 401(k). Knowing them is crucial.
-
Padding Your 401(k)taxes Try these money-saving moves to help boost your contributions.
-
What's Your Deduction?Tax Breaks What made the original IRA a no-brainer investment was a simple, indisputable fact: Contributions were deductible.
-
Four Facts of Living Truststaxes Trusts are a valuable tool, but they may not be for everyone. It pays to know the ins and outs before you put your trust in a trust.
-
Tax Changes Ring in the New Yeartaxes As you prepare to fill out your 2010 tax return, take note of new tax rules that will apply for 2011.
-
Tax Hikes for Small Business?
business Would higher taxes for upper incomers put a damper on small business?
-
5 FAQs About Tax Law Changes for 2010-11
Tax Breaks We help you figure out your tax planning for this year and beyond.
