Retirement through an Employee Stock Ownership Plan (ESOP). It’s something that most of us don’t think we need to worry about until we get older. Retirement is also something that most of us don’t think we can worry about right now. After all, we have student loans, expensive healthcare costs, rising housing prices, kid’s college, aging parents, and a host of other financial worries that usually push the idea of retirement to the back of our mind. Additionally, retirement can be overwhelming. Most people have no idea what to invest in, how the investing process works, what tax implications our decisions may have, and most of all; how much money do you need to retire. 

While all of these questions will be answered in future articles, this article will start on the ground floor with the question: What are the different types of retirement plans? There are several different types of retirement plans and in this article, we will be addressing #12: Employee Stock Ownership Plans (or ESOPs). These articles will give you an idea of what to look for when deciding on how to save for retirement and what type(s) of retirement accounts to save in.

Types of Retirement Plans

1. Traditional IRA
2. Roth IRA
3. 401(k)
4. 403(b)
5. SIMPLE IRA
6. Simplified Employee Pension (SEP)
7. Salary Reduction Simplified Employee Pension Plan (SARSEP)
8. Payroll Deduction IRA
9. Profit-Sharing Plan
10. Defined Benefit Plan
11. Money Purchase Plan
12. Employee Stock Ownership Plan (ESOP) (this article)
13. Thrift Savings Plan (TSP)
14. 457 Plan

IMPORTANT: READ THIS BEFORE CONTINUING

Before we get into the types of retirement accounts, it is important to make one key distinction. A retirement account, itself, is not an investment. If you say something to the extent of, “My 401(k) hasn’t done very well this past year and I’m thinking of picking a different one” you would be making an incorrect statement.

Think of it like this: There are 14 different types of retirement accounts (we will discuss the other 13 in different articles). Each one of those retirement accounts should be thought of as a cooking pot. If you cook something in that pot and you don’t like what it tastes like, you don’t dump the contents into another pot and hope that it tastes better. You change the ingredients of that pot to something else. Now think of the ingredients as different investment products (stocks, bonds, cash, mutual funds, and/or a host of other products/ingredients).To get the taste you want, you change the ingredients, not the pot. You may be wondering, what ingredients do I put into my pot? That is a fair question, but you cannot answer that question until you figure out what pot is best for you. Now buckle up and find out what the 14 different types of retirement accounts (pots) you have at your disposal.

Credit: Nicholas Gras: https://unsplash.com/@armgd

(12) Employee Stock Ownership Plan (ESOP)

An ESOP is a really cool retirement vehicle but it isn’t available to many people. If it is available to you, you will probably know it because it will be a popular topic around the water cooler at your job. Here’s how an ESOP works:

If the owner(s) of a privately held business wants to sell the business (usually because the owner wants to retire), there are a few different ways that they can do it.

1. They can sell it to another business owner who will run it similarly to how they did.
2. They can sell it to a private equity firm.
3. They can sell it to the employees of the business.
4. They can close the business altogether.

It’s not too hard to wrap your mind around the business owner doing number 1, 2, or 4. But what happens if the business owner wants to sell the business to their employees? That is where an ESOP comes in. 

In an ESOP, the business owner can elect to sell some, most, or all of the business to the employees. The owner can have the employees pay for the business for a price that the owner desires. The owner can also elect to just give the business to the employees if they so choose. (That would be cool.)

One of the good things about an ESOP from the perspective of the business owner is that an ESOP gives the owner options of how to sell the business to the employees. They can sell it all at once or sell it little by little over time giving the owner time to gradually step back from the day-to-day grind.

There are a lot of different tax implications and legal jujitsu that the business owner must take into account when selling their business through an ESOP to the employees. But that is WAY outside the scope of this article.

Let’s not lose sight of what this article is about: You and your retirement savings. 

If you are an employee and your employer has told you that you have the right to buy into the ownership of the company through an ESOP, awesome! There are a lot of things to consider.

1. How well or poorly is the business run?
2. How well or poorly will the business operate in the future?
3. How much does a share of ownership cost?
4. Are there any legal issues that the business is currently entangled in?
5. Do you see yourself working for this company for the foreseeable future?
6. After the owner leaves, who will be running the business?
7. What say will you have in the direction of the business?
8. Etc.

These are all the same questions that you would need to ask yourself (among several others) when investing your money into any single company like Apple, Netflix, Walmart, etc.

If you are offered an ESOP, you will be able to purchase shares of the company at a specified price, just like if you were buying a share of any other company. The only difference is that (1) you are buying the company that you work for and (2) you are purchasing shares of the company in a retirement vehicle.

Because you are purchasing it in a retirement vehicle, that means that all of the rules and regulations regarding retirement accounts will apply. 

1. Contribution Limits (as of 2021): Generally, the contribution limit that you will have for an ESOP is 25% of your payroll amount. You generally cannot invest in the company with money that does not come directly from your paycheck. This can vary some depending on the legal classification of your company. To be sure, check with the HR department.

2. Contribution Deductions (as of 2021): All contributions to an ESOP will be tax deductible just as if they were to an IRA, 401k, or another retirement plan.

3. Early Withdrawal (as of 2021): You should never take money out of an ESOP until you are at least 59 ½. This is the most important consideration of an ESOP (and any retirement account for that matter). This money is not there for you to buy a boat or go on a vacation, it is to retire with. If you take money out of an ESOP before age 59 ½ you will pay taxes and a penalty of 10%. For example, if you are single and make $50,000/year and want to withdraw $10,000 from an ESOP, you will be taxed 22% ($2,200) + 10% penalty ($1,000). You will only come home with $6,800 (even though you withdrew $10,000) after taxes and the penalty.

There are some more nuanced rules and regulations with ESOPs that aren’t applicable to most other retirement accounts, but they are in more depth than we need right now. If you are employed at a company that has an ESOP, check with your HR department and they will be able to give you more specifics. 

Final Thoughts

An ESOP is a really good retirement tool. It is also a really good recruiting tool for businesses. After all, who doesn’t want to work for a business where you can be a part-owner? Most of us do.

With that being said, an ESOP can also be dangerous. 

Think about it. If you get your money from your job to pay your bills and that same job is also responsible for your retirement, what happens if that business goes bankrupt?

If it goes bankrupt, you lose your job AND your retirement. That can be really scary.

And don’t think it can’t happen to you. It happens to people all the time. 

My suggestion would be to invest in BOTH your ESOP and whatever other retirement vehicle you have available to you (401k, 403b, IRA, etc.) That way if the business were to ever go belly-up, you don’t have all of your eggs in that basket.

I hope this has helped and that you have a better understanding of how to make your life awesome.

Until next time!