What is a Trust?

In general, it helps to understand with a trust is in general. A trust is a legal arrangement where one party, the “trustor” or “settlor,” transfers assets, such as money, property, or investments, to another party, the “trustee,” to manage and hold for the benefit of specific individuals or entities, known as “beneficiaries.”

Trusts are commonly used for various purposes, including estate planning, asset protection, and charitable giving. They provide a structured way to safeguard and distribute assets according to the trust document’s terms, often helping to avoid probate and providing flexibility in managing and preserving wealth for future generations.

What is an ESOP Trust?

An ESOP trust, short for Employee Stock Ownership Plan trust, is a specialized trust used in the context of an Employee Stock Ownership Plan (ESOP). As retirement plans that are designed to enable employees to become partial or full owners of the company, ESOPs work by holding shares of the company’s stock in a trust. The ESOP trust holds these shares on behalf of the employees participating in the ESOP.

How does an ESOP Trust work?

ESOP trusts are a key component of ESOPs, and they play a crucial role in facilitating employee ownership in a business. ESOPs are often used as a succession planning tool, allowing business owners to sell their ownership to their employees while maintaining the company’s independence and legacy.

ESOP Trusts and how they work
  • Creation: The company establishes an ESOP trust, which is typically a separate legal entity.

  • Funding: The company contributes shares of its stock or cash to the ESOP trust. This trust then uses these contributions to purchase shares from existing shareholders, such as the company’s founders or other shareholders.

  • Employee Participation: Eligible employees become participants in the ESOP, and the trust holds shares on their behalf. Over time, employees may accumulate more shares in their ESOP accounts as they earn them through employment.

  • Voting Rights: While the ESOP trust holds the shares, employees typically have the right to vote on major company decisions, even though the trustee has the authority to vote on certain matters that directly affect the shares held by the trust.

  • Retirement Benefits: When employees retire or leave the company, they can receive the value of their ESOP account in the form of company stock or cash, depending on the plan’s terms. This provides a retirement benefit based on the company’s performance.

  • Tax Benefits: ESOPs can offer tax advantages to both the company and employees. Contributions to the ESOP are typically tax-deductible for the company, and employees may have the opportunity to defer taxes on the gains from their ESOP shares.