Owning a piece of the company they work for is a dream many Americans share. One of the ways this becomes a reality is through an employee stock ownership plan or ESOP.

ESOPs are frequently confused with employee stock "option" plans. Although the two may accomplish some of the same goals, they are completely different in structure and administration.

ESOPs are basically a means of transferring ownership of a company to its employees in the form of a benefit they receive at a later date. This deferral is one of the reasons ESOPs fall under a different set of rules than stock options.

Both public and private companies may have ESOPS, although they are often associated with private firms. However, they are relatively expensive to set up and administer compared to many stock option plans.

Companies have different reasons for setting up an employee stock ownership plan. These include

Companies have different reasons for establishing ESOPs; some involve benefits for the employee, and others accrue to the company.

It is helpful to understand some things about qualified retirement plans before we move to more details about ESOPs.

The specific law that governs ESOPs and other pension or retirement plans is the Employer Retirement Income Security Act of 1974 (ERISA). This spells out certain requirements the company must meet to qualify and protects your rights.

Qualified retirement plan means the IRS has approved the structure and administration of the plan and it will receive favorable tax treatment. This is important to the company, but it is also important to you. It is important because there are no tax liabilities you have to deal with until you actually receive a benefit from the plan, with the exception of dividends, covered later in this lesson. This happens when you leave the company or retire.

Unlike most of the other plans in this book, ESOPs don't require you to use any of your own money, ever. Stock acquired through the ESOP is yours in most cases without any cost to you.

If you sell the stock at some point, you will owe tax on that amount and, like most retirement plans, if you pull money out before you reach 59½, there may be a 10 percent penalty on top of other taxes.

An employee stock ownership plan is a retirement benefit that transfers ownership to employees of the company. A trust administers the ESOP and buys shares of the company's stock on behalf of the employees.

The ESOP allocates shares based on salary or some other common measure. The ESOP can even borrow money to buy shares with the company contributing money to repay the loan. The shares can be newly issued or belong to existing owners.

Employee stock ownership plans are qualified retirement plans and that is good news for you. This designation means your stock appreciates tax-free in the account administered by the ESOP trustee.

An ESOP can buy stock with a market value of $10 per share that appreciates to $50 per share and no taxes are due as long as it stays in the trust.

That's the good news. The bad news is you will owe income tax plus a 10 percent penalty on any stock or cash you take out of the plan before age 59½. That's the standard penalty on early withdrawals from qualified retirement plans.

When you leave the company or retire, the ESOP will pay you your share of the trust account in stock or cash, assuming it is 100-percent vested.

You will normally have 60 days from the time you receive the stock or cash, known as a qualified distribution, to roll it into another qualified retirement plan. This plan could be an IRA, for example.

If you meet this deadline, you avoid the tax penalty and defer income tax on the balance until you begin making withdrawals after age 59½.

Many private companies require you to sell the stock back to the ESOP, the company, or another shareholder. You can put the cash into an IRA and use it to buy stock in a publicly traded company, buy some other type of security, or leave it in cash.

Anytime you can gain an asset for free, it's a good deal. That's the reason ESOPs are so popular with employees. Unfortunately, you can get too much of a good thing.

It is never wise to have all your investments in one stock even if it costs you nothing. There have been too many stories where companies have gone out of business and their stock became worthless. When this happens to an ESOP company, no stock held by the trust or workers who have left or retired is worth anything. If you haven't made other investments to fund your retirement, you could be looking at a very bleak situation.

Some companies offer other retirement plans in addition to ESOPs, such as 401(k) programs that allow you to choose the investment vehicle for your retirement funds. Be careful not to "double dip" by buying company stock in another retirement plan while you are accumulating shares in the ESOP.

The rules governing ESOPs recognize this danger and provide for some relief for people who have been in the plan for 10 years or more and who have reached age 55.

During the next five years, these employees can diversify up to 25 percent of the stock acquired by the ESOP. The ESOP must supply some alternative investment vehicles or hand over stock or cash to the employee. Check with your ESOP trustee for specifics of your plan.

ESOP participants have very little control over the plan except through the administrator of the trust. Most of the procedures are set and operate without any input from you.

Unlike options, you have little control over what happens or when. One area you may have some influence over is timing of ESOP distributions. If you are planning to leave the company or retire and have some latitude about when those events are going to occur you may be able to help yourself.

Employees of publicly traded companies can keep an eye on the market and try to exit when the stock is high. Your plan will state how and when it arrives at a value of the stock for distribution purposes.

Unfortunately you may be in the other situation. The stock is at a low point. Maybe you can wait a year or six months to retire in hopes that the stock might rise.

Look at the stock market listings in your newspaper or online and you will see numbers representing a 52-week high and low. These two numbers may be quite a distance apart, even for "blue chip" stocks. High tech stocks may show an even larger gap between the high and low.

It is not possible to know exactly where the high and low prices are going to be; not even the investing experts can do that. You can, however, be aware of where the stock is relative to those two points and which direction it seems to be moving.

For example, at press time, here were prices for a couple of popular stocks:

These examples show how it pays to watch the market. Notice that IBM is just about in the middle of its 52-week high and low. Microsoft is on the low side, while GE is very near its 52-week high.

Information regarding the movement of the stock in recent trading is available online, but that is no guarantee it will keep going that direction. If the company's stock looks like GE's, it might be a good time to give notice.

It is very important to understand when the ESOP sets the value of the stock for distribution. If you must give the company six months notice before you retire and the ESOP sets the value on the day you retire, then guessing where the stock will be is probably a waste of time.

Workers with private companies may have an easier or harder task in deciding when to leave. Private companies are required to get an outside independent valuation of their stock annually.

Check your plan to see when stock is valued for distribution. If it uses the most recent valuation until the next schedule valuation, you may want to decide which will be higher.

The company may have had a bad year before the last valuation and that depressed the stock price. If you know the company has done much better this year, you may want to wait until the next valuation for a high stock price. On the other hand, if the company has had a bad year this year, you may want to use the last valuation.

The important thing is to check with the plan to completely understand what the procedures are and how they can be used to your advantage.