All about your employee stock ownership plan

Kaplan recommends that employees understand three important concepts about their plan:

  • The account's value. The value of an employee's account will vary at times, and it's important to keep track of those changes. "In a public company, the value will fluctuate with the market value of the stock of the company," Kaplan says. "In a private company, the value will be determined by an appraisal, which is performed at least once a year."
  • Benefit payments. A retirement benefit is useless until the employee actually gets to use the funds. "You want to know how and when the benefits under the plan will be paid to you or to your beneficiary," Kaplan says.
  • Tax issues. Some ESOP benefits are taxed at a lower rate than other retirement benefits, so employees should understand the tax liabilities of their plan. "If certain requirements are met, a substantial portion of your distribution from an ESOP may be taxed at long-term capital gains rates," says Kaplan. Long-term capital gains rates are substantially lower than most ordinary income tax rates.

Enhance your retirement security

Employees should not rely entirely on an ESOP for their retirement.

"I always recommend that employees contribute to their 401(k) plan, save what they can from after-tax income and supplement these savings with their ESOP account," says Coltman. "The old saying, 'don't put all your eggs in one basket,' still rings true."

Because an ESOP consists of just one company's stock, it lacks diversification, which presents significant risk of loss. On the other hand, ESOPs can provide substantial gains.

"A 401(k) account which had been invested in an S&P 500 index fund over the past 10 years would have produced virtually no growth in value, and most ESOP accounts have done much better, some very significantly," Kaplan says.

One way to mitigate risk is to invest in a diversified portfolio of funds that represent different asset classes.

"It's rare for an employer to provide an ESOP as the sole vehicle for the retirement benefits of its employees," says Kaplan. Most employers also offer a 401(k) or other type of plan, he says.

In addition, certain protections are in place for older workers, says Jeffrey Gluck, managing director of CBIZ, a financial advisory services firm. "Once an employee reaches 50 years old and 10 years in the plan, the ESOP trust has to start divesting of the employee's stock (and investing in) other things," Gluck says. "So it won't all be held in company stock anymore, but it will still be controlled by the ESOP trust."

Finally, employer contribution rates are significantly higher for employee stock ownership plans than for other retirement plans. "So most employees who are covered by ESOPs have a dual source of retirement funds: a diversified account and a company stock account," Kaplan says.

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