The Employee Stock Ownership Plan (ESOP) is a special form of qualified profit sharing plan that invests primarily in employer securities. While ESOPs are subject to all of the normal requirements of a qualified retirement plan such as participation, vesting, contribution limitations, and non-discrimination, ESOPs are unique in that the plan is permitted to purchase employer stock, and take out loans to purchase the employer stock, without violating the prohibited transaction rules. Because of the ability to purchase employer securities, ESOPs provide unique planning opportunities generally not available with other qualified plans.

The following charts illustrate three different ways to structure an ESOP.

  A private company, that maintains an ESOP for its employees will experience a potentially large cash problem in the future. This is due to the fact that all private companies are obligated to repurchase the shares the ESOP distributes to the employees. This obligation necessitates careful planning. Corporate owned life insurance could be the tool that meets the needs of a company faced with just such a problem.

  An Employee Stock Ownership Plan (ESOP) is a special form of qualified profit sharing plan1 that invests primarily in employer securities. Deductible contributions are made from the corporation to the ESOP in the form of employer stock.

  This stock is then allocated to the individual participant employee’s account inside the ESOP. Following termination of employment, by way of retirement, dismissal, resignation, or death, the ESOP will begin distributing, to the employee, his vested shares.

  All private companies will have to repurchase these shares upon the request of the employee.

  This repurchase obligation often places an immense strain on the future cash flow of a company. A plan must be developed to fund this obligation and alleviate the strain on the future cash flow. In addition, the proposed plan must be flexible enough to provide funds of various amounts at various times because the timing of the repurchase obligation is uncertain.

  As a funding method, variable universal life insurance has two distinct advantages. The first advantage, favorable taxation, is actually two-fold. First, it can accrue cash surrender value, which may grow income taxdeferred and be accessed on a tax-advantaged basis. Secondly, a life insurance policy’s death benefit is generally received by the corporation free of federal income taxation.

  The other major advantage of life insurance is timing. By using variable universal life, the corporation may be able to provide the necessary funds regardless of when the obligation arises, provided the policy has sufficient cash value accessible to the company.

  Because most employees will receive their benefits during life, the repurchase obligation is more likely to be funded through the withdrawal and loans of the policy’s cash surrender value rather than the death benefit. However, the death benefit proceeds can be used in the case of premature death. This flexibility allows the corporation to structure the policy to best meet their anticipated, and even unexpected, needs.

  An important question when using life insurance to fund the repurchase obligation is on whom does the corporation place the policy. The answer to this question will vary depending upon the specific circumstances of the case. As an example, one particular strategy is to place the insurance on certain key employees. This way the life insurance performs “double duty” by helping fund the repurchase obligation and also compensating the company for the death of a key individual. Another strategy is to insure individuals who have rather large account balances.

The corporation makes deductible contributions of stock to the ESOP. This allows for an income tax savings without an expenditure of cash.

The corporation uses this cash savings to make premium payments of the life insurance policy. The corporation is the owner and sole beneficiary of the policy and as such, has access to the cash surrender value.

The ESOP distributes stock to the participant following the end of his employment with the company.

The participant, or his estate if employment ended due to death, elects to demand the company to repurchase the shares.

The company accesses either the cash surrender value, or uses the death benefit to fund this obligation.

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