I am hearing increasingly from certain thought leaders that current ESOP laws do not create “good” employee ownership plans.
Anytime we ESOP advocates encounter someone who takes such a view of ESOPs, we need to ask ourselves, “Why does that person think ESOPs are not good employee ownership plans?” When we know the answer, we can counter the ESOP cynic’s point of view.
In my experience, there are three main criticisms of ESOPs. I’ll deal with each one in a separate blog post.
The first criticism maintains that ESOPs are bad retirement plans.
The argument here is that retirement plans should be diversified, to reduce the participants’ risk of losing all their assets.
But, ESOPs are great retirement plans!
First, more than 40 years’ worth of data show that, in the vast majority of instances, ESOP accounts provide better returns for their participants than any other ERISA plan—including the more numerous 401(k) plans. Simply put, employees who participate in an ESOP typically walk away with more money in their pockets than those who participate in a 401(k).
Second, data going back more than 20 years evidence that while 50 percent of Americans don’t have access to any retirement plan, more than 50 percent of employees who participate in an ESOP have access to a second retirement plan through their employer—usually a 401(k). So, most ESOP participants have access to the better returns available with an ESOP and the potential diversification of a 401(k).
What’s more—unlike 401(k)s—employees can participate in the vast majority of ESOPs without any out-of-pocket expense. So not only do most ESOP participants have access to a second retirement plan, the ESOP leaves money in their pockets that they can use to invest in that plan.
What if participants lack the funds to invest in that second plan—again, usually a 401(k)? Plenty of people live paycheck to paycheck and don’t see how they can afford to contribute to a 401(k) plan. For these people, the ESOP may be the only retirement plan they can afford—and may make retirement possible when it otherwise might not be.
That means ESOPs could be particularly good at sharing the wealth with those who need it most. It also means that any time an ESOP enables someone to retire, someone else gets a chance to earn a paycheck.
Finally, many praise the reduced risk that comes when investing in diversified assets. But diversification is meaningful only when the assets have significant value. Under the law, employees can diversify up to 50 percent of the assets in their ESOP accounts as they near retirement age. At that point, they are more likely to have significant values that benefit from diversification. And, because they are closer to retirement, those employees also will have greater need for the security that diversified investments are supposed to offer.