401(k) Considerations for ESOP-Owned Companies

January 2024

Employee Stock Ownership Plans (ESOPs) provide an amazing array of cultural and financial benefits to both companies and employee-owners. However, understanding the unique fiduciary considerations of integrating a 401(k) with an ESOP is critical for ensuring the financial wellbeing of your employees as they approach retirement.  

Lebel & Harriman Retirement Advisors is committed to guiding you through the complexities of managing your company’s 401(k) plan, especially when it includes an Employee Stock Ownership Plan (ESOP).  In this article, we outline three key aspects you should consider:

1. Addressing Equity Concentration in ESOPs

Equity Overweight Challenges

Participants in ESOPs often face the risk of significant equity concentration in their retirement portfolios. This over-exposure to company stock can be a double-edged sword, offering potential growth but also posing heightened risks, particularly in market downturns as employees near retirement.

Shifting to a Conservative Glidepath

To mitigate these risks, you may want to evaluate the appropriateness of a more conservative target date fund glidepath as your Qualified Default Investment Alternative (QDIA). This approach aims to gradually reduce the risk profile of the investment portfolio as an employee nears retirement age. By incorporating a more conservative glidepath, you can provide a counterbalance to the equity-heavy nature of ESOPs, ensuring a diversified and age-appropriate asset allocation.

Implementing the Strategy

Our team can assist in analyzing your current QDIA and suggesting adjustments to align with this more conservative approach. This process includes an in-depth analysis of your employee demographics, risk assessments, and participant behavior.

2. Tax Diversification Through Roth Offerings

Current Limitations of Pre-Tax Contributions

In our experience, most ESOPs are funded with pre-tax contributions, which may lead to a lack of tax diversification in retirement savings. This scenario can create tax-related challenges for employees during their retirement years.

Benefits of Introducing Roth Options

Incorporating a Roth 401(k) option into your plan can provide a much-needed avenue for after-tax contributions. Contributions to a Roth 401(k) grow tax-free, and withdrawals in retirement are also tax-free, subject to certain conditions. This can be particularly advantageous for employees who expect to be in a higher tax bracket in retirement.

Educational Initiatives and Implementation

We emphasize the importance of educating your employees on the potential advantages of tax diversification in retirement and the role of Roth in that. This education can include personalized sessions, illustrative examples, and group education sessions highlighting the differences between traditional and Roth 401(k) options.

3. Incorporating ESOP in Retirement Plan Education

The Need for Holistic Retirement Planning

A significant aspect of retirement preparedness is ensuring that employees understand how their ESOP fits into their overall retirement picture. Many employees may not be fully aware of how to integrate their ESOP holdings into their retirement projections.

Educational and Demonstrative Sessions

To address this, we suggest organizing educational sessions and demonstrations, possibly through your 401(k) recordkeeper’s web platform. These sessions can demonstrate how to incorporate ESOP holdings into retirement planning tools, providing a more comprehensive view of retirement income sources.

Customized Support

Our team can facilitate these educational initiatives, tailoring them to your company’s specific context. We can also provide tools and resources that enable employees to make informed decisions about their retirement planning, considering their unique financial situations.

Next Steps

As fiduciaries, it is incumbent upon you to continually assess and adapt your retirement plan offerings to meet the evolving needs of your participants. We encourage you to review your current 401(k) and ESOP structures in light of these considerations. Lebel & Harriman Retirement Advisors is here to assist you in this process. Our team of experts can provide guidance on implementing these strategies.

In conclusion, integrating an ESOP with your 401(k) plan presents unique challenges and opportunities. By addressing the issues of equity concentration, tax diversification, and retirement planning education, you can significantly enhance the retirement readiness of your employees and increase employee-owner engagement with the ESOP benefit. We are here to support you and your employee-owners in these endeavors and look forward to continuing our partnership in securing a prosperous retirement for your workforce.

For more information or if you would like to benchmark your current retirement benefits, please contact Nate Moody, CPFA at (207) 773-5390 or nmoody@lebelharriman.com.

This document is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

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