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Is ESOPS actually a good idea?

Warren Buffet, as we all know, talked about diversity: “[it] It makes little sense for anyone who knows what they are doing. “Being someone who owns his retirement savings is primarily in a diversified index fund, which quotes pain. Again, when it comes to my retirement savings, I really don’t have the time or desire to be someone who “knows what I’m doing.” So I diversify with the intention of ensuring market returns and often recommending others like me to do the same. That’s why I’m a little nervous about the provisions that encourage the adoption of the Employee Stock Ownership Plan (ESOP) when the Safety 2.0 Act was signed into law in December 2022.

There is a quick primer before you understand why I feel nervous. After all, many people who read this article may be more familiar with Aesop’s fables (Please shoot). The fastest way to explain ESOPs is probably to compare them to 401(k), a retirement plan that most workers know better.

contribute: In 401(k), employees contribute a small portion of their salary (for both traditional and after tax before tax) of Roth. Employers will usually meet a portion of their employees’ contributions. In ESOP, employees usually do No contribute. Instead, employers allocate stocks of company stocks to employee accounts based on things like salary and tenure.

invest: In 401(k), employees choose how to invest donations from the menu, including active management and passive management of funds. ESOP accounts usually only hold employees’ shares, although employees can diversify 25% of their account shares at age 55 and increase to 50% by age 60.

Account Value: In 401(k), a person’s account value is usually obvious because the assets involved are publicly traded. The value of an ESOP account is the value of the employer’s stock. If a company trades publicly, the value may be clear, but for private companies, it is only available annually.

distributed: In 401(k), employees over 59½ can withdraw their donations and returns as they wish (comply with the required minimum distribution rules). If the payment is paid before tax, the withdrawal will be subject to ordinary income tax. In ESOP, the distribution is more program-specific and is usually not controlled by participants.

From above, you can see why ESOP is attractive and often receives bipartisan support. First, ESOP does not require the contribution of employees and is therefore often considered an ideal choice for middle-income workers (although it is always possible for employers to compensate for the offer of ESOP by reducing their employee wages). About one-third of ESOPs in construction and manufacturing – considered to be middle-income industries – reinforce this appeal. Second, ESOP provides employees with ownership shares in the company, adding momentum and empowerment.

However, the comparison with the 401(k)s also makes it clear why pushing ESOPS makes me a little nervous. This is not only a fact most 50% of the worker’s account can be invested in assets outside of the company’s stock. The fact that there is a lack of investment diversification compared to one fact is that if a person’s only retirement plan is ESOP, then a person’s life will remain unchanged. A person’s salary, health insurance and retirement accounts can all be tied to a company.

Fortunately, this concern is somewhat misplaced. The reason is – as shown in Figure 1 below, most companies sponsoring ESOP also sponsor another program, usually 401(k). Additionally, some single-plan companies with ESOP combine it with 401(k) components to become something called “KSOP”, an acronym for Keystone Savings and Profit Sharing Plan. In KSOP, employers provide competitions through company stocks, but can invest more broadly in employee contributions, thereby increasing diversity.

In short, ESOP is a complement (not a replacement) to more diverse retirement tools in most cases. If future policies encourage ESOP to maintain this balance and encourage the adoption of 401(k), then ESOP will continue to be a great way to help workers accumulate wealth, while also encouraging ownership and empowerment.