All ESOPs Are Not Created Equal

QUESTION: My husband just started a new job. He tells me the company offers the usual medical benefits plus something called an ESOP. He says it’s some kind of retirement plan, but he doesn’t know more than that. Can you tell me anything more about it?--C. A. S.

ANSWER: ESOP is short for employee stock ownership plan. It is, indeed, a type of retirement plan--but probably not the type that you’re most familiar with. Unlike the most common type of company retirement plan, the ESOP doesn’t guarantee the employee a predetermined amount of money when he or she retires. Rather, the value of an ESOP, like the price of the stock in the plan, could rise and fall dramatically between the time an employee joins it and the time of retirement.

ESOPs are designed not just to help employees save for retirement but also to spread around the ownership of a company’s stock to employees at all levels of the company. Hence, ESOPs must make membership available not just to highly paid employees and top executives at the company but to the vast majority of the rank and file. Also, they must invest primarily in the stock of the company offering the ESOP. (Most company retirement plans, conversely, are prohibited from investing more than 10% of their assets in the company’s own securities. The other notable exception is profit-sharing plans.)

Although companies offering ESOPs must make the plan widely accessible to employees at all levels, they are permitted to exclude, and often do exclude, employees who have worked for the company less than a year, those who are classified as part-time or temporary and workers who are younger than age 21. Be sure your husband checks with his new company for details on how long he must be employed before he can participate in the ESOP.

Another detail worth checking is the ESOP’s vesting rules. Even if your husband is immediately allowed to participate in the plan, it could be as long as 15 years before he is fully entitled to keep the money in the fund.

Since ESOPs are viewed by some employers as a way to boost employee morale and productivity, ESOPs tend to vest more quickly than other retirement plans. Generally, an employee who decides to leave the company after five years of membership in the ESOP would be entitled to take at least part of the retirement funds with him.

But there are some ESOPs that vest all at once after 10 years. In other words, if an employee stayed on the job even one day short of 10 years, he wouldn’t be entitled to a penny of the ESOP money that his employer had been setting aside for him all those years. (Both the Senate and House versions of tax reform propose to speed up vesting in all types of company retirement plans.)

How much your husband’s new company intends to contribute to the plan each year is another question that your husband should ask. As a rule, companies contribute at least 5% of a participating employee’s annual compensation to that employee’s ESOP account. At the other extreme, employers generally can contribute no more than 25% of an employee’s yearly compensation to a maximum of $30,000. That amount is likely to change after January, 1988, when adjustments for cost-of-living increases are scheduled to begin.

(There are some exceptions to the rule of ESOP contribution ceilings. If, for example, no more than one-third of the company’s yearly contributions go to to such key employees as officers and big shareholders, then the government permits the company to double the ceiling to $60,000.)

Although the employer typically divides the yearly ESOP contributions using a formula based on each employee’s compensation, length of service can also be factored in.

A few companies also allow employees to make contributions to the employer-funded ESOP. Those employees in such plans can contribute no more than 10% of their wages if the contributions are voluntary and no more than 6% if such employee contributions are mandatory. More often than not, however, employees aren’t invited to make contributions to their ESOPs because of strict government rules that companies have to abide by if they borrow money to buy stock for a company retirement plan funded in part by employees.

Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Los Angeles Times, 780 Third Ave., Suite 3801, New York, N.Y. 10017.