Today, I want to debunk one common misconception about ESOP: that it can replace your 401(k). I will use 401(k)s as an example in this article, but these points can apply to any other workplace retirement plan.
To understand why the ESOP does not replace your 401(k), it is important to realize how they are different:
Your 401(k) is funded by you, while the ESOP is funded by your company. While you might indirectly control how many shares of stock you get in the ESOP, you directly control how much money you save into the 401(k). This can help when it comes to planning for retirement.
Your 401(k) has multiple investment options, while the ESOP is only company stock. The ESOP can be great if the company does well, but it can also be extremely risky. This is especially true when you consider your ability to earn income is also tied to the success of the same company. The investments in your 401(k) might include large and small stocks, international stocks, and different types of bonds. This can help you spread out your risk or invest more conservatively, which is crucial whether you are just getting started or approaching retirement.
Your 401(k) value is updated every day, while the ESOP is only valued periodically (usually once per year). We don’t recommend checking your accounts constantly, but when trying to plan for retirement, it can be harder to tell where you stand with the ESOP.
The money you put into your 401(k) always belongs to you, while the funds in the ESOP often have more restrictions. Your 401(k) money can be taken with you if you leave the company (note that this does not always apply to the match from your company). The funds in your ESOP are often subject to a vesting schedule, meaning you may not receive the full value when you leave the company.
The ESOP alone is unlikely to provide enough money to retire on. Since you don’t directly control how much goes in or how it gets invested, you need something to supplement it. This is where the 401(k) comes in. Your 401(k) will allow you to adjust your savings amount and fine-tune your investments to make sure you are taking the appropriate amount of risk for you.
An ESOP is an excellent benefit offered by your company, but it is important to realize that it does not replace your 401(k). They are both key pieces of your retirement plan and complement each other very well.
If you are an employee who wants to know more about the role your ESOP plays in your retirement plan, we are happy to discuss our experiences and guide you. For business owners who want to learn more about potentially offering an ESOP to their employees, give us a call, or stay tuned for a future blog post on the topic.
Thanks for reading!