In today's episode of Equity Compensation Guidebook, I'm going to break a bit from the normal equity compensation topics and talk about ESOP's, which stands for Employee Stock Ownership Plan. I've had quite a few people ask me about these recently and thought if people are asking I should probably do a quick episode on them. A simple explanation of an ESOP is that it's a company funded retirement plan that holds company stock in accounts for participants. It's safe to say it is similar to a profit sharing plan.
You will want to hear this episode if you are interested in...
- Explanation of an Employee Stock Ownership Plan [1:29]
- Highlights of an ESOP [2:56]
- One tool in your retirement plan toolbox [4:39]
- Distribution rules [5:53]
- This week’s FLASHBACK [8:39]
Employee Stock Ownership Plan explained
ESOP's are not limited to private companies as public companies can have them too. I'm sure I'll cover why ESOP's are so popular and why they're used in another episode. Just know they're more common than you think. Last data I saw said there were nearly 6,600 ESOP's in the U S representing almost 11 million employees.
An ESOP is a qualified, defined contribution employee benefit plan that invests in the stock of that employer company. Qualified means it meets federal rules that qualify it to be a retirement plan and provide certain benefits to participants and the employer like tax advantages. Defined contribution simply means a defined amount is contributed to the plan regularly. Typically every year. Basically, you know, what amount is going in. It's then up to the performance of the investments that determine what it is worth when you take it out. In the case of an ESOP, that performance is of the company stock.
One tool in your retirement toolbox
Something I have to stress is that ESOP's are ONE tool in your retirement planning toolbox. I've done episodes and preached before about concentration risk. This is not uncommon in the world of equity compensation. My point is just think about how much of your retirement plan you want to commit to ONE company stock. 40%, 50%, 60%? It isn't unusual to see a retiree with a strong ESOP plan retire with 85% of their net worth in that one company stock! I get a little stressed out, just thinking about all that money on one stock.
Just pay attention to how much of your net worth is tied up into one stock. I understand that you may not be able to diversify depending on your situation, but it's important to at least know what the number is. Many plans do have rules that allow a participant to start diversifying a portion of their stock balance once they reach 55 and have 10 years of service. Know your rules and talk to your benefits people!
This week’s FLASHBACK: Steam whistle
As you may have heard before I worked the steam locomotive at Cedar Point one Summer. Our days on the train were spent going around in a big 15 min loop. Working 12 hour shifts you did your best to pass the time. One day, the engineer I was working with decided to try and play a song or two on the whistle. It was steam operated and it was loud. We went around and when we came back into the main station the train manager, who was a full time year round employee, was standing there waiting for us. This guy never came out of the engine house if he didn't have to so that was not exactly a good sign for us.
Apparently a couple of park VPs happened to be walking in the back of the park where the train ran and they heard our attempt at a steam music concert and, you know, because they're corporate guys they did not exactly appreciate our musical renditions. Lucky for us, train workers were too hard to replace because it was hot, dirty, and complex, so we got away with a warning.
Connect With Dan Johnson