ESOP is our ONLY retirement plan? Is that crazy?

[Guest jw112098]

My company is a 100% S-Corp ESOP. The ESOP is our only retirement plan. I have attended many ESOP seminars and conferences, and cannot find any other company that uses the ESOP as the sole retirement plan.

I have been asking for years to install another, more viable retirement plan(401k) but it's falling on deaf ears. There seem to be many many ESOP advocates out there but when I ask the question of what happens when the company goes belly-up,burns down, etc, I get the old hairy eyeball !

I have a significant amount of $$$ (over 100K) in my ESOP account, and I am nervous it won't be there when I retire ( in 20 years).

What can I do to convince the company president that we employee owners need to diversify our retirement funds in the future? Am I wrong in assuming we're up the creek if the place goes belly up? Will the creditors understand I need that stock valued at what it was before the 2nd Great Depression?

[Disco Stu]

You can put your concerns in writing to the trustee of the existing plan and to the owners of the company. It is possible to add 401(k) features to an existing ESOP. Many companies have ESOPs coupled with other types of plans.

There may be very legitimate reasons for the company not to add another plan however. ESOPs can create a big cash crunch for non-publicly traded companies. Also depending on the ESOP, the company may also run afoul of the IRS deduction limits by adding another plan.

An additional item to keep in mind regarding your investment in the existing ESOP...There is a diversification requirement in ESOPs for employees who have reached 55 years of age and 10 years of plan participation. The really short version is that you are able to diversify up to 50% of your positions. If the company doesn't offer suitably diverse investment choices in the ESOP or a related pension plan, you can take your money and roll it somewhere of your choosing.

This requirement is in the Internal Revenue Code to prevent exactly what you are concerned about...retirees having positions in only one investment, and having it go bad just when they need the money most.

Best of luck.

[david rigby]

There may also be a deduction issue. The Internal Revenue Code contains limits on how much a company can deduct for its contributions to all its qualified pension and profit-sharing plans, including ESOPs, 401(k), etc.

If the company has "maxed out" using only the ESOP, then no more can be deducted. Putting in a 401(k) would not change the total, only which plan(s) it is spread to, and who is putting it in.

[RLL]

jw112098 ---

There certainly are many other 100% ESOP-owned companies that have an ESOP as the only retirement plan. Whether this is a wise policy obviously depends on the facts and circumstances of each particular ESOP company.

It is usually up to the board of directors of a company to adopt an additional retirement plan. This is usually done only upon recommendation of the company's management and after consideration of the company's entire compensation and benefits package.

You are correct in your concerns regarding retirement security.....if the value of company stock diminishes, the value of your allocable share of the ESOP's company stock will be reduced. If company stock becomes worthless, your ESOP benefits will become worthless (except to the extent that the ESOP has "other investments" or that you have exercised your ESOP "diversification" rights). In the event of bankruptcy, it is unlikely that company creditors will be very concerned about the value of your ESOP benefits (or lack thereof).

Have you expressed your concerns to management ...preferably through the human resources department? Have you asked about the possibility of establishing a 401(k) plan?

It is possible for an ESOP to be designed to allow for total tax-deductible contributions (by the company and the participants) to a 401(k) plan and the ESOP in amounts up to 25% of covered payroll....even in an "S" corporation. It is also possible for a 401(k) plan to allow for only employee elective contributions and no company contributions. Perhaps these approaches should be addressed with appropriate decision-makers at the company.

[Guest jw112098]

Thank you all for the replies, I have talked to our HR department, as well as the company president. The HR dept. really has no clue to anything, and the president knows that in order to add another retirement plan in conjunction with the ESOP, it will be a tremendous amount of work. It will also be an accounting nightmare which I have been told is simply is not worth the trouble.

I guess I'm stuck with the status quo. I was hoping to hear from someone who was in a similar situation. The annual esop contribution is 15% of earnings, so it could be broken down or split up into another plan. I'm not looking for an explanation of how an esop works, I would like some info from anyone who has implemented or been part of implementing a secondary plan to an esop.

I also have another question, why is there a 75 person limit for S-corp esops, and is that a soft number that can be flexible? All replies appreciated, thanx.

[Guest P A Weick]

Have you also thought about opening a Roth IRA. At least, to the extent of $2000 a year, you can control your own destiny. Make sure that you qualify as there are limitations on income based on tax filing status.

[Disco Stu]

To the best of my knowledge there is not a 75 participant limit on ESOPs of s-corps. I believe that there is a limit of 75 shareholders for an s-corp. The esop trust would only count as one shareholder.

If the company has a knowledgeable service provider (accountant, attorney, recordkeeper) that provides administrative or legal services for the ESOP, they could likely handle a lot of the setup work involved with getting a new plan off the ground. Also, most of the people on this board are happy to answer general questions you might have about implementing a secondary plan to an esop. Keep in mind though that free advice is worth what you pay for it.

If new employee beneifts are viewed as "a tremendous amount of work" and "an accounting nightmare" it sounds like you have an uphill fight though. I guess the point I would make to the employer regarding this would be that there are a lot of companies out there (big and small) that don't have the same viewpoint. All other things being equal, those companies are more attractive to potential employees than your company is. As far as the administrative burden...there are service providers (payroll, accounting etc.) out there that can do a lot of this work for the company.

[RLL]

jw112098 ---

In looking at the 75-shareholder limit applicable to S corporations, it is clear (under the Internal Revenue Code) that an ESOP trust is treated as one shareholder. This was confirmed by an IRS private letter ruling in early 1999. There is no limit on the number of participants in an S corporation ESOP.

In addition, you should note that the 15% of covered payroll limit on deductible contributions may be increased to as high as 25% when a 401(k) plan is combined with an ESOP that includes a definite contribution formula (in the form of a money purchase plan).

[BeckyMiller]

Adding a 401(k) plan does almost nothing to the plan sponsor's financial reporting. So that piece is not an accounting nightmare.

Where the accounting nightmare could arise is in the nondiscrimination testing. Again, this does not have to be a major issue, as RLL mentionned it is possible to exceed the 15 percent limit, if the employee salary deferrals are limited to a fixed percentage of pay, say the lesser of 10 percent or $10,500, two segments of the "accounting nightmare" is eliminated, the annual addition limit and the 402(g) limit. If only non-highly compensated employees are allowed to make contributions, there is no testing required. That is a term of law, so someone would need to verify who that is from year to year. If the highly compensated people want to participate, there are some safe harbor formulas to eliminate the testing.

In other words, it doesn't have to be all that bad. In today's marketplace the 401(k) is becoming nearly as common as paid vacation days. You can't persuade the folks to change their minds, but you might be able to find some articles that could help. I suggest that you use benefitslink and search under "401(k) safe harbor" plans to see if you can find some good magazine articles. The CFO magazine regularly runs articles on 401(k) plans and providers. That might be a starting place since it focuses on the business need for such arrangements.

[Guest sampat]

All,

Does the 25% of Payroll tax deductibile limit for other retirement plans include ESOP contributions on part of an S-Corporation or an S-corp can set up a retirement plan with 25% of Payroll contribution in addition to ESOP?

Sampat

[BeckyMiller]

Under current law, the 25 percent of pay limit includes employee 401(k) contributions and the employer contributions to any defined contribution plans, including ESOPs, 401(k), profit sharing, etc.

But keep an eye towards new legislation. There are a bunch of folks in Congress who propose that some or all of the employee salary deferrals to a 401(k) plan should not count against this limit.