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How Employee Stock Ownership Plans Fit Into Retirement Planning

Is an employee stock ownership plan considered a retirement plan? ESOPs can be used for retirement, but they can be risky in some situations. Learn more with this guide to ESOP retirement plans.

When planning for retirement, you may encounter a wide assortment of retirement plans and products. Employee stock ownership is a type of employee benefit that you may be offered when starting a new job. These types of plans allow you to receive stock and can be used to support your retirement savings.

 

If you’re considering enrolling in your company’s employee stock ownership plan, it’s important to understand how these types of plans fit into retirement planning.

 

What is an employee stock ownership plan?

An employee stock ownership plan (ESOP) is an employer-provided benefit in which companies distribute stock shares to employees. Typically, your employer sets up a trust fund for you and other employees. The employer then contributes to the plan in the form of company stock shares, borrowed money or cash. Shares in the fund are allocated to individual employees, who receive their shares once they leave the company.

 

While your shares are held by ESOPs, you won’t pay any taxes on them. If you leave the company or retire, you have the option to sell the stock on the market or sell it back to the company.

 

Is an ESOP a retirement plan?

 

ESOPs are considered qualified, defined contribution retirement plans, according to the IRS. This means that the amount of money your company contributes to the plan every month is fixed, but the amount of benefits you’ll end up receiving is variable. Since ESOPs are qualified by the IRS, these plans are required to follow certain guidelines and regulations.

 

ESOPs have become quite common and popular retirement plans. According to the National Center for Employee Ownership, ESOPs were almost unknown before 1974. Today, there are 6,460 plans in operation that cover 14.2 million employees.

 

>>Related Reading: What Is a Qualified Retirement Plan?

 

Pros and cons of ESOP retirement plans

If you’re joining a company that offers an ESOP, you’ll need to think carefully about the pros and cons of this retirement option before enrolling. Below, we cover some advantages and disadvantages of using ESOPs to grow your retirement savings.

 

Advantages of ESOPs

 

There are several advantages to ESOP retirement plans:

 

  • ESOPs are funded by your employer. Employees usually aren’t expected to make their own contributions to an ESOP—instead, these plans are a perk on top of your salary and other retirement benefits. With plans like a 401(k), even if your employer contributes, you’ll still be largely responsible for funding your retirement. ESOPs can be a valuable way to build your retirement savings without having to invest your own money.
  • You can play a role in your retirement fund’s success. The work that you’re doing for your employer contributes to the company’s profitability and stock value, which in turn can make your ESOP shares worth more. After you leave your employer, you can still benefit from the company’s success by selling your shares.
  • ESOPs offer valuable tax benefits. With ESOPs, you won’t be taxed on your shares until you sell them. Since you’ll be minimizing your taxes, you could potentially invest the money you’re saving into alternative retirement plans.

 

Disadvantages of ESOPs

 

While ESOPs have many advantages, there are also some drawbacks that you should be aware of before deciding to use this plan to support your retirement:

 

  • ESOPs can be risky retirement plans when used alone. When you have all of your retirement savings in one type of plan, your portfolio won’t be diverse. Furthermore, the value of ESOPs is dependent on the company’s performance, so if your company is doing poorly, you may not be able to save up enough money for retirement—especially if you’re nearing the end of your career.
  • If you’re new to the company, your ESOP shares may not be fully vested. “Vesting” refers to the process of gaining ownership of your retirement assets. With ESOPs, employees generally have to work for their company for several years before their shares become fully vested. This may be anywhere from three to six years, depending on your company’s plan. If you leave the company before you’re 100% vested, you may have to forfeit some of your shares.
  • It can be difficult to find employers who offer ESOPs. ESOPs are only available to S-corporations and C-corporations, so many employers—including partnerships and many professional corporations—aren’t able to offer them. ESOPs are also expensive for companies to set up and run, which may discourage some companies from offering them.

 

Should you consider an ESOP retirement plan?

There’s no simple answer as to whether an ESOP is a good retirement planning strategy. You’ll need to weigh the pros and cons and decide whether an ESOP is right for your financial situation. If you need help determining what your retirement savings goals should be—and seeing whether or not you’re on track—consider using a retirement savings calculator or consulting your private banker.

 

Before signing up for an ESOP, be sure to ask about the availability of alternative retirement plans. Many employers offer both an ESOP and a 401(k), giving you more decision-making power in your retirement savings. ESOPs can be risky when used as your sole retirement account, but when you pair them with other retirement plans, they can be a great way to bolster your savings without taking on too much risk.

 

Because the company’s health plays a direct role in how much your shares are worth, it’s recommended to do thorough research into the company and its past and current performance before enrolling in your company’s ESOP. In general, ESOPs at newer, up-and-coming businesses are likely going to be riskier than ESOPs at well-established businesses with strong performance history.

 

>>Related Reading: 401(k)s vs. IRAs: Pros and Cons of Each

 

Questions to ask before signing up for an ESOP

 

If your company offers an ESOP retirement plan, ask yourself the following questions before making a decision about whether or not you should enroll:

 

  • How much risk are you comfortable taking on?
  • What other benefits does the employer offer? Do they have any other retirement plans available?
  • Do you already have some retirement savings in an existing account, such as an IRA?
  • What is the company’s stock valued at currently, and how has their stock performed over the past few years?
  • When will you become fully vested in the ESOP program?

 

Not sure how to plan for retirement? Cadence Bank can help

Planning for retirement can be complicated and overwhelming at times, but working with a trusted private banker or financial advisor can help. At Cadence Bank, we offer a variety of personal retirement planning services and tools to help you meet your retirement savings goals. Our investment professionals can help you understand the pros and cons of different retirement solutions, including 401(k)s, IRAs, ESOPs, profit-sharing plans, pension plans, mutual funds and more.

 

We also understand that everyone’s retirement goals are unique, which is why our investment management services are customized for each client’s individual needs. We’ll start with an in-depth analysis of your situation, and use this information to create a diversified portfolio that matches your risk and return profile.

 

If you’d like to learn about our personal retirement planning or investment management services, contact a Cadence Bank wealth management advisor today. We’re happy to discuss all of your available retirement options, so you can make informed decisions on how to grow your wealth and build your savings.

 

 

This article is provided as a free service to you and is for general informational purposes only. Cadence Bank makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.

 



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