Retirement Planning and Employee Benefits for Financial Planners

1. Retirement Planning and Employee Benefits for Financial Planners Chapter 6: Stock Bonus Plans and Employee Stock Ownership Plans

2. 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…

3. 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.

4. 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.

5. 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

6. 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

7. 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

8. 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.

9. Leveraged ESOP (1 of 2)

10. 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.

11. 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%

12. Disadvantages of ESOPs • Owner • Dilutes ownership • Company • Expensive administrative costs • Conflict of interest issues • Put option impact on cash flow • Employee • Lack of diversification

13. 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

14. 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

15. 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