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What Is an ESOP? How Employee Stock Ownership Plans Work

Employees participating in an ESOP receive shares in the company.

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Updated Mar 19, 2026 · 3 min read

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What is an employee stock ownership plan (ESOP)?

An employee stock ownership plan, or ESOP, is an employee benefit plan that gives workers shares in the company they work for. Employees receive the value of those shares when they retire or leave the company.

There are thousands of ESOPs in the U.S., according to the National Center for Employee Ownership, which maintains a database using company documents filed with the Department of Labor

There are thousands of ESOPs in the U.S., according to the National Center for Employee Ownership, which maintains a database using company documents filed with the Department of Labor National Center for Employee Ownership. National ESOP database. Accessed Mar 19, 2026. .

ESOPs span industries, such as manufacturing, science, technology, finance, insurance and real estate. Many of the largest employee-owned companies are supermarkets, construction companies, architecture and engineering firms, manufacturers and health providers.

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How does an ESOP work?

Here are the basic functions of an ESOP.

The company forms an ESOP trust, which is a legal entity that will hold shares until they are contributed to individual employee accounts.

The company forms an ESOP trust The company forms an ESOP trust , which is a legal entity that will hold shares until they are contributed to individual employee accounts.

The company funds the trust with new shares of the company or cash that is used to purchase shares from the company’s owners. An ESOP trust also can borrow money to purchase the company stock (in that scenario, the company then makes tax-deductible contributions to the trust to pay off the loan).

The company funds the trust The company funds the trust with new shares of the company or cash that is used to purchase shares from the company’s owners. An ESOP trust also can borrow money to purchase the company stock (in that scenario, the company then makes tax-deductible contributions to the trust to pay off the loan).

The trust gives shares of the company to employees. Generally, employees who have at least one year at the company receive shares from the trust, and those shares vest over time. That means it can take years for an employee to gain full rights to the shares they’ve received. Workers typically don’t pay taxes on their shares until they leave the company.

The trust gives shares of the company to employees. The trust gives shares of the company to employees. Generally, employees who have at least one year at the company receive shares from the trust, and those shares vest over time. That means it can take years for an employee to gain full rights to the shares they’ve received. Workers typically don’t pay taxes on their shares until they leave the company.

The company buys back shares from former employees. When an employee with vested shares leaves the company, the company typically buys back the stock, giving the worker cash for the value of the shares. Payouts can be delayed, though, depending on the plan’s design

The company buys back shares from former employees. The company buys back shares from former employees. When an employee with vested shares leaves the company, the company typically buys back the stock, giving the worker cash for the value of the shares. Payouts can be delayed, though, depending on the plan’s design National Center for Employee Ownership. What Is an ESOP?. Accessed Mar 19, 2026. .

Why companies have ESOPs

There are three common reasons companies have ESOPs.

1. Transferring ownership

ESOPs are most commonly used to help private company owners sell their stake in the business. To do this, the ESOP trust purchases shares at fair market value from one or more of the owners of the company, allowing that owner to leave the company without selling the business to an outside buyer. This can have its downsides because even though the ESOP pays fair market value for the shares, a third-party buyer might be willing to pay more. However, closely held companies, such as a family business, may opt to sell the company to its employees (via the ESOP) as a way of protecting it from outside buyers.

2. Employee benefits

An ESOP can be an employee retirement benefit, similar to a 401(k) or other employee equity plan.

ESOPs are required by law to include all employees, though there are some eligibility requirements. They’re also required to allocate shares in a way that doesn’t favor the company’s highest earners. Often, ESOPs allocate shares to employees based on a percentage of their compensation. They also may contribute a set dollar amount to every eligible employee or calculate contributions based on a combination of compensation and tenure.

ESOPs can give employees ownership in the company, which helps align workers’ interests with company success. Employees’ shares may become more valuable if the company’s value increases.

For employees, an advantage of an ESOP is that they get shares without making any out-of-pocket contributions. But unlike other types of employee equity plans, such as restricted stock units (RSUs), workers participating in an ESOP can’t access the value of their shares until they retire or leave the company.

For employees, an advantage of an ESOP is that they get shares without making any out-of-pocket contributions. But unlike other types of employee equity plans, such as restricted stock units (RSUs) , workers participating in an ESOP can’t access the value of their shares until they retire or leave the company.

As a retirement plan, ESOPs differ from other employee stock ownership plans in at least one key way. Distributions may face tax penalties if they’re taken before age 59 ½ (though there are some exceptions) IRS.gov. Retirement topics - Exceptions to tax on early distributions. Accessed Mar 19, 2026. . That may influence what you do with your shares — or the value of those shares — after leaving your job.

🤓 Nerdy Tip

Employee equity programs can be complex. A financial advisor could help if you’re wondering what to do with an ESOP or another form of equity compensation.

3. Borrowing money

A company may create an ESOP if it’s looking for a less expensive way to borrow money. The trust can borrow money from a bank or other lender and then use it to buy newly issued stock from the company. The company then makes tax-deductible contributions to the ESOP, which uses the money to pay off the loan

Pros and cons of ESOPs

There are advantages and drawbacks to ESOPs for employees at companies that offer them. But keep in mind that each ESOP is governed by its own rules.

There are advantages and drawbacks to ESOPs for employees at companies that offer them. But keep in mind that each ESOP is governed by its own rules. Pros

Employees receive shares without any out-of-pocket costs.

May be offered in addition to other retirement benefits such as a 401(k).

Participants have some voting rights as shareholders.

Cons

Typically have a years-long vesting schedule.

Workers typically can’t access the value of their shares until after leaving the company. There may be tax penalties for early distributions.

May have provisions that delay buying back an employee’s shares after the employee has retired or left the company.

» MORE: Learn the difference between an ESOP and an ESPP

» MORE: » MORE: Learn the difference between an ESOP and an ESPP

How do I cash out my ESOP after I quit?

If you quit your job, what happens to your ESOP account depends first on how vested you are.

If you’re partially or fully vested, you’re typically entitled to whatever portion of the account is vested. Generally, the payout can be in cash or shares, with the option to sell the shares back to the company at fair market value. When the payout occurs and whether cash or shares depends on the plan design. ESOPs can delay payouts by up to six years when you quit your job.

If you’re partially or fully vested If you’re partially or fully vested , you’re typically entitled to whatever portion of the account is vested. Generally, the payout can be in cash or shares, with the option to sell the shares back to the company at fair market value. When the payout occurs and whether cash or shares depends on the plan design. ESOPs can delay payouts by up to six years when you quit your job.

If you’re not vested (and you haven’t reached your plan’s retirement age), you might lose all rights to your ESOP if you leave the company.

If you’re not vested If you’re not vested (and you haven’t reached your plan’s retirement age), you might lose all rights to your ESOP if you leave the company.

To know if you’re vested in your ESOP, you’ll need to know your plan's vesting schedule.

ESOPs commonly either vest gradually (so you earn a right to, say, 20% of the account per year for five years) or all at once (so you earn a right to 100% of the account after completing a certain number of years of service).

If all or part of your account is vested and you quit before age 59 1/2, you may be able to roll your ESOP balance into your next employer’s retirement plan or into an IRA to avoid paying a tax penalty on an early withdrawal National Center for Employee Ownership. When Will I Be Paid? The ESOP Participant's Guide to ESOP Distribution Rules. Accessed Mar 19, 2026. .

Article sources

NerdWallet writers are subject matter authorities who use primary, trustworthy sources to inform their work, including peer-reviewed studies, government websites, academic research and interviews with industry experts. All content is fact-checked for accuracy, timeliness and relevance. You can learn more about NerdWallet's high standards for journalism by reading our editorial guidelines. National Center for Employee Ownership. National ESOP database. Accessed Mar 19, 2026. National Center for Employee Ownership. What Is an ESOP?. Accessed Mar 19, 2026. IRS.gov. Retirement topics - Exceptions to tax on early distributions. Accessed Mar 19, 2026. The ESOP Association. What is an ESOP?. Accessed Mar 19, 2026. National Center for Employee Ownership. When Will I Be Paid? The ESOP Participant's Guide to ESOP Distribution Rules. Accessed Mar 19, 2026. About the author Taryn Phaneuf Taryn Phaneuf Taryn Phaneuf is a lead writer and content strategist covering wealth management, financial planning and other investing topics. She previously covered personal finance news. Taryn joined NerdWallet in 2022 after reporting on business, education and public policy for more than a decade. See full bio.

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What Is an ESOP? How Employee Stock Ownership Plans Work

You’re our first priority. Every time.

What Is an ESOP? How Employee Stock Ownership Plans Work

What is an employee stock ownership plan (ESOP)?

How does an ESOP work?

Why companies have ESOPs

1. Transferring ownership

2. Employee benefits

3. Borrowing money

Pros and cons of ESOPs

How do I cash out my ESOP after I quit?

You’re our first priority.
Every time.