How to Cash Out an ESOP After Quitting

An Employee Stock Ownership Plan (ESOP) is a retirement benefit allowing employees to gain ownership in their company. It holds company stock in a trust for employees, offering a unique wealth accumulation avenue. When employment ends, understanding how to access these funds is key. This guide helps former employees navigate cashing out their ESOP.

Eligibility and Valuation for Distribution

Before initiating an ESOP distribution, former employees should understand the requirements for receiving funds. Vesting determines the portion of an ESOP account balance an employee is entitled to. Vesting schedules typically range from three to six years, with “cliff vesting” meaning 100% entitlement after a specified period (e.g., three years), and “graded vesting” allowing a percentage of ownership to accrue each year until full vesting. If employment terminates before full vesting, any unvested shares are forfeited.

ESOP distributions are triggered by specific events, such as termination of employment, retirement, disability, or death. The timing varies based on the reason for separation and the plan’s rules. For retirement, disability, or death, distributions generally begin within one year after the close of the plan year. For other terminations, distribution typically begins no later than the sixth plan year following termination. If the ESOP used a loan to acquire shares, distributions might be delayed until the loan is repaid.

The value of an ESOP account is tied to the company’s stock value. For privately held companies (over 90% of ESOPs), shares are not publicly traded, so their value is not determined by market prices. Instead, ESOP shares are appraised annually by an independent valuation firm to determine fair market value. The distribution amount is based on the most recent valuation completed before the distribution date.

Understanding Distribution Options

Former employees have several ESOP distribution options, each with different financial and tax implications. A lump-sum distribution provides the entire vested account balance in a single payment, either cash or company stock. This option may be available for smaller balances or as specified by the plan.

Alternatively, installment payments are paid out over several years, typically up to five. For very large balances (e.g., over $1,380,000 in 2024), the period can extend up to ten years. Payments are usually made at least annually.

Some ESOPs permit the distribution of company stock rather than cash. If a privately held company ESOP distributes stock, the company must repurchase shares from the former employee via a “put option.” This ensures a market for non-publicly traded shares. The company must offer to repurchase stock at fair market value, with the put option available for at least 60 days after distribution and again for 60 days in the subsequent plan year.

To defer immediate taxation, individuals can directly roll over ESOP funds into another qualified retirement account, such as an Individual Retirement Account (IRA) or a new employer’s 401(k) plan. A direct rollover transfers funds from the ESOP trustee directly to a new account custodian, avoiding recipient handling. This prevents the distribution from being a taxable event and allows funds to grow tax-deferred. If funds are distributed directly to the former employee, they have 60 days to complete an indirect rollover to avoid immediate taxation and penalties.

Tax Considerations for ESOP Payouts

Understanding ESOP distribution tax implications is important, especially if funds are not fully rolled over into another qualified retirement account. ESOP distributions are subject to ordinary income tax in the year received, similar to other retirement plan distributions. Federal income tax rates apply based on the recipient’s total taxable income.

For individuals receiving distributions before age 59½, a 10% early withdrawal penalty typically applies, in addition to ordinary income tax. Exceptions to this penalty include separation from service at age 55 or later, total and permanent disability, or qualified unreimbursed medical expenses.

A unique tax advantage for ESOP distributions received as company stock is Net Unrealized Appreciation (NUA). NUA applies to lump-sum distributions of employer securities. The stock’s cost basis (acquisition price) is taxed as ordinary income upon distribution. The “net unrealized appreciation” (increase in value from acquisition to distribution) is taxed at long-term capital gains rates only when shares are later sold. To qualify for NUA, the entire ESOP account balance must be distributed as a lump sum in a single calendar year, and the employer stock must be distributed “in-kind” to a taxable brokerage account. Rolling over stock into an IRA forfeits the NUA tax benefit.

Required Minimum Distributions (RMDs) apply to ESOPs, similar to other qualified retirement plans. Participants must begin taking distributions by a certain age, generally 73, or later if still employed. The specific age depends on the individual’s birth year. State income taxes may also apply to ESOP distributions, depending on the state of residence.

Navigating the Distribution Request Process

After understanding eligibility, valuation, distribution options, and tax implications, formally request the ESOP distribution. Contact the plan administrator, who manages the ESOP. This may be the former employer’s human resources department, the ESOP trustee, or a third-party administrator.

The plan administrator will provide necessary forms and documentation to initiate the distribution. These commonly include a distribution request, tax withholding election, and rollover instruction forms. Carefully review these documents and provide all requested information accurately.

Required information often includes personal details, contact information, banking details for direct deposit, and specific rollover instructions, including receiving institution and account numbers. Submit completed forms according to the plan administrator’s instructions, via mail or a secure online portal. Retain copies of all submitted paperwork for your records.

The timeline for processing an ESOP distribution request can vary, but it typically takes several months. This period allows for stock valuation, compliance with plan rules, and adherence to IRS regulations. Maintain communication with the plan administrator and follow up on any delays to ensure timely receipt of funds.