Yes, as long as it follows common best practices.
While there are some great retirement plans offered by companies, the overall data are pretty dismal. Only 48% of all private sector employers offer any kind of retirement plan, but about 80% of those with more than 50 employees offer such plans. Some companies still offer traditional pension plans that pay out a percentage of your highest pay for the rest of your life, but these are increasingly rare. Just 15% of private industry workers have access to this kind of plan. Most of these are in large companies and/or unionized companies.
Most retirement plans now, however, are 401(k) plans. According to the Bureau of Labor Statistics, 70% of employees in the private sector have access to a retirement plan, but just 54% of eligible employees participate (some surveys show even lower numbers). That is because 68% of all 401(k) plans require employees to contribute their own money, and some employees don’t contribute at all. The lower the wage, the lower the participation rate. Only 25% of the lowest-paid workers participate, compared to 52% of those in the next 25%. Employers typically budget about 3% of pay for 401(k) and similar plans, much of it based on a matching formula. Just over half of all employees work for an employer who contributes 50 cents on each dollar deferred or less, usually up to a maximum. So, if you put in $1,000, your employer might put in $500. Nine percent of workers work for an employer with a larger maximum, but 38% work for an employer with no match at all—it’s all your money. Overall, about two-thirds of the funds in 401(k) accounts come from employees.
Because 401(k) plans are usually based on employee deferrals, and because higher-income people defer more, their benefits are skewed upwards—in other words, higher-paid people receive a higher-percentage contribution from the company than lower-paid people.
Why ESOPs Are Different
In the vast majority of ESOPs, the employee contributes nothing. ESOP companies generally contribute more to their plans than companies do to 401(k) plans, typically from 4% of pay up to significantly greater amounts. So, if your employer is putting in 4% of pay or more, your plan is more generous than typical 401(k) plans. ESOPs distribute contributions based on relative pay, not what you defer. So, if the company contributed 5% of pay to the ESOP, everyone gets 5% contributed to them. In 401(k) plans, lower-paid people would typically get less than that. ESOPs thus tend to be much better plans for people who have a hard time contributing to 401(k) plans.
Are ESOPs Too Risky?
Critics of ESOPs say they are too risky. If the company stock drops significantly, employees will have inadequate assets for retirement. By contrast, 401(k) plans and other retirement plans that employers offer have to be diversified—they are or can be invested in a variety of things. Diversification is a good thing—it means that if one investment fails, you still can do well with others. The risk that you will end up with major losses is much lower than if you are only invested in one investment, no matter how good that investment is. However, there are some things to consider here. First, when you get to age 55 and have 10 years in the plan, you can start to diversify your ESOP. Second, most ESOP companies offer a 401(k) plan, and youcan (and should!) still invest in that, just as you would if there were no ESOP. It is still a great deal, because your money is not taxed before it is invested. That typically means you automatically make a first-year return on your investment of 30% or more just because you did not pay taxes. ESOP companies are somewhat more likely to offer a secondary retirement plan, in fact, than most companies are likely to offer any kind of plan at all.
Finally, there is a less obvious (but very important) factor. Your retirement plan won’t do you much good if you don’t have a job and have to spend that money just to get by. The good news about ESOPs is that ESOP companies lay people off at one-third to one-fifth the rate of non-ESOP companies. This more stable employment means you stay in your job, see your benefits vest and, usually, receive salary increases as you go along rather than being laid off and starting over again. You may have to wait in a new job to be able to join a retirement plan, and you may need to start vesting again. But nothing is guaranteed, so it is generally positive news. Overall, ESOP participants end up with about three times the retirement assets as employees not fortunate enough to be in ESOPs. This statistic will vary a lot from company to company, though. Although it’s not common, some ESOPs do go bankrupt or see dramatic declines in stock value. So, don’t just assume that the money will be there. Save what you can in a 401(k) or other savings vehicle.
Planning for Retirement
Think about what you will need to retire, and make a plan. There are lots of useful tools online that help you calculate your retirement needs and what to expect from your retirement plans. The NCEO offers a series of recorded one-hour webinars, each one geared towards a different stage of your ESOP career, that can help you create the right plan for you.
FAQs
Yes, as long as it follows common best practices.
Is ESOP a good retirement plan? ›
Having a large portion of money in an ESOP alone is restrictive and lacks diversification. By relying on just this type of plan, you may be putting too much weight on one component of your retirement plan. It's best to have additional retirement plans in place, like a 401(k) or IRA.
What is the downside of an ESOP? ›
ESOPs are inflexible in some respects…
While ESOPs are flexible in many ways, they are subject to legal constraints. ESOP rules require that contributions be allocated based on relative compensation (ignoring compensation above a certain level) or some more level formula.
What is the average ESOP balance at retirement? ›
The average employee in an ESOP company has accumulated $134,000 from his or her stake in the business, according to a 2018 Rutgers University study. This is 29 percent more than the average 401(k) balance of $103,866 reported by Vanguard the same year.
What happens to my ESOP when I retire? ›
Under the company's ESOP, they have the right to receive 20 shares after the first year, and 100 shares total after five years. When the employee retires, they will receive the share value in cash. Other types of stock ownership plans may be offered instead of an ESOP.
Do you lose ESOP if you quit? ›
The IRS has a concise explainer of vesting in retirement plans (like an ESOP). If you are not 100% vested in employer contributions to your account when you quit, you will only lose (forfeit) the percentage you have not vested in. So if you are 50% vested, you will lose 50%.
What is the normal retirement age for ESOP? ›
Age 65, Termination, or 10th Anniversary: Notwithstanding any distribution rule to the contrary (including the special rule for leveraged ESOPs noted above), ESOPs must allow participants to take a distribution no later than the 60th day following the last day of the plan year in which the latest of the following ...
What is the major problem with ESOPs? ›
ESOPs are costly to set up and maintain and can turn into headaches during times of financial stress. The failure of an ESOP company can result in the employees losing their jobs as well as the value of their ESOP accounts.
Can an ESOP go broke? ›
In fact, many ESOPs are formed at companies in service industries, so they really have very little in the way of physical assets in any event. If they run out of cash — which is always what precipitates bankruptcy — there is nothing left with which to pay anyone else, including ESOP participants.
How do I avoid taxes on my ESOP payout? ›
A tax-free rollover of an "eligible rollover distribution" from an ESOP is allowed under IRC § 402(c)(1). Amounts rolled over from an ESOP are not taxed as your income, if the rollover is made within 60 days of the ESOP distribution.
As an ESOP participant, you have the right to diversify part of your ESOP account balance once you have 10 years or more of participation in the plan (defined as the ESOP or a predecessor plan whose assets were transferred to the ESOP) and are 55 years or older.
What is the ESOP 25% rule? ›
ESOP Rules for Participant Allocations
The 25% is a combined limit that includes ESOPs, 401(k)s, profit sharing, and stock bonus plans offered by the company. ESOP rules also dictate the amount of annual compensation that counts as eligible pay for participation in the plan.
What is the ESOP 30% rule? ›
Section 1042 has, for many years, allowed the owners of non-publicly traded C corporation stock to defer capital gains tax on up to 100% of proceeds from a sale to an ESOP if: (1) the ESOP owns 30% or more of the stock after the sale; and (2) the seller reinvests the proceeds in stocks and bonds of U.S. operating ...
What are the disadvantages of an ESOP retirement plan? ›
It can cost more than $100,000 to set up an ESOP. There are also ongoing costs associated with maintaining the ESOP, such as trustee fees. An annual valuation is required, and — as a retirement plan — the ESOP is subject to regulatory oversight and compliance.
How long does it take to be fully vested in ESOP? ›
The 4-year plan works as such: 25% of the shares are instantly vested after the cliff of a year, 50% of the shares are vested after 2 years, 75% after three years and 100% after four years. But, in the US, ESOP vesting is almost always monthly after the cliff for many tax reasons.
What happens to ESOP when employee dies? ›
If an employee retires, dies or is disabled, he generally will be 100% vested in his total account balance. After an employee's participation in the ESOP ends, he (or his beneficiary) is eligible to receive a distribution of his vested benefit. There are many permissible times and methods for making this distribution.
Who benefits from ESOPs the most? ›
As an exit strategy, an ESOP provides business owners — and their employees — with several distinct advantages. ESOPs can reward long-time employees, provide business continuity, retain a role for the owner and provide liquidity to the owner — potentially with tax advantages for all parties.
What is the success rate of ESOP? ›
In particular, they more frequently achieve ratings in CPARS of Excellent or Very Good than other firms. For instance, 79.1% of 100% ESOPs received a rating of exceptional or very good on “Quality” versus 57.2% among other firms.
What is the average ESOP payout? ›
In 2018, Employee Stock Ownership Plans Distributed a total of $126.7 billion. An estimated $1.37 trillion in value is held by ESOPs in the US, that's an average of $129,521 per employee owner.
