Understanding ESOP Plan Provisions

ESOP. A qualified Defined Contribution, employee retirement plan, for the exclusive benefit of plan participants/beneficiaries. To learn more about the basics of ESOP’s check out our previous post here. Once you have some insight on the basics of an ESOP it’s time to gain an understanding on more of the details, ESOP plan provisions.



  • Generally there are age and service requirements, with specific entry dates
  • Longer wait than typical with 401(k) plans

Contribution Allocations

  • Often requires working 1,000 hours and being employed on the last day of the year
  • Allocations are most often based on compensation
  • May also use a points formula based on compensation
  • May not be an integrated true cross-tested formula


  • Capped to the usual IRS qualified plan limit ($280,000 for 2019)
  • Certain components may be excluded, such as bonuses – additional testing may be needed.


  • Minimum is a 6 year graded or 3 year cliff, with some exceptions
  • Years of service generally either based on the plan year (work 1,000 hours) or elapsed time
  • Usually fully vest at normal retirement, disability or death
  • Normal retirement can be just an age, or can also require 5 years of participation
  • Can define early retirement based on age and service.
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Distribution Timing

  • Retirement, disability, or death – as soon as administratively possible
  • Other termination usually delayed 5 years unless small vested balance
  • C corporation can also delay until loan is fully paid.

Distribution Options

  • Typically substantially equal installments over 5 years
  • Lump sum for smaller balances
  • Stock distributions with a “put” or “call” option

Diversification Rights

  • Closely-held corporations
    • Must be offered to anyone who is age 55 and has at least 10 years of ESOP participation
    • In first five years, must be able to diversify up to 25% of all shares ever allocated to the participant; sixth year can diversify up to 50%
    • Options – transfer to 401(k) plan, permit cash distribution, and/or offer at least 3 other investment options within the ESOP
    • Have 3 months after year-end to make the election, with payment in 6 months
  • Publicly-traded corporations – only requirement is 3 years of service







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