ESOPs and 401(k)s are both retirement plans subject to the Employee RetirementIncome Security Act. In broad terms, here are some key differences between these plans.
source of contributions
ESOPs
The company invests its money.
- In the vast majority of ESOPs, the company buysshares on behalf of the employees and placesthose shares in a trust; employees incur no out-of-pocket expense to participate.
- ESOPs provide a retirement option for thoseemployees who cannot afford to make a regularpayroll deduction to a retirement plan.
- Employees who can afford a payroll deductionstill can make that contribution at many ESOPcompanies. The latest survey of ESOP Associatio members shows 93.6 percent of responding companiesoffer both an ESOP and a 401(k). Employeesat these companies have two retirement plans.According to Pew, more than half of all employeesdon’t participate in any retirement plan at work.
401(k)s
Employees invest their money.
- Typically, employees participate in a 401(k) byinvesting their own money via payroll deduction.
- Employees who cannot afford a payroll deduction(and therefore cannot participate) often includethose who are starting their careers, work inlow-paying jobs, have significant family obligations,etc. In short, the employees who most needa retirement plan may be the ones who can leastafford to participate in a 401(k).
- A big incentive for participating in a 401(k) isgetting the matching funds offered by most employers. To get all these funds, employees must contribute a certain amount (often twice what theemployer contributes). Again, some employees cannot afford this investment.
Investing Options
ESOPs
Usually, ESOPs buy company stock only.
- ESOPs are designed by law to purchase theemployer’s stock primarily.
- By law, older workers who qualify may diversifytheir holdings by converting ESOP shares intoassets outside the company.
- Some companies offer more generous diversificationoptions than those required by law.
401(k)s
Employees invest from a list of options.
- In 401(k)s, a limited number of investment vehiclesare offered. (Some companies find that havingtoo many options confuses participants.)
- Employees are responsible for researching andchoosing from among the investment optionsavailable. They can shift how and where money is invested.
Form of Compensation
ESOPs
Employees earn shares, not money.
- Employees earn shares based on certain criteria (such as salary, tenure, etc.) The share value mayrise or fall, based on how the company performs.
- Employees have a vested interest in ensuring the company performs well, since they share in the rewards via the ESOP.
401(k)s
Employees earn money, not shares.
- Employees invest the money they contribute andthe money they receive from the employer.
- There is no long term connection between the value of the 401(k) plan and the performance of the employer.
CONTROL
ESOPs
Employees usually don’t control ESOP shares.
- The ESOP trust holds the company shares on behalf of employees. Employees cannot trade these shares on the open market.
401(k)s
Employees control their 401(k) accounts.
- Employees can do as they wish with these funds, including altering investments or withdrawing them. (In most situations, financial experts discourage early withdrawals from retirement plans.)
TIMING FOR PAYOUT
ESOPs
Employees may need to wait for funds.
- It takes time to dispose of stock. When employees leave an ESOP company, the plan may require that payouts be spread out over several years.
401(k)s
Employees take possession quickly.
- Employees possess both money they contribute and vested funds from the employer. When employees leave, vested funds are available.
BENEFITS COMMUNICATION
ESOPs
Company contribution is hard to express.
- The value of an ESOP account varies based onfactors such as: salary, tenure, when the employeeleaves, macro economic events, etc.
401(k)s
Company contribution is easy to express.
- The company 401(k) match is a percentage of salary, which is easy for employees to understand and to compare against other potential employers.
