ESOP & Retirement: What Burns & McDonnell Employee Owners Should Know

By: Scott Sturgeon, JD, MBA, CFP®

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As an employee of Burns & McDonnell, along with the host of perks the company offers, perhaps most notable is your Employee Stock Ownership Plan or ‘ESOP’ in which almost any employee of the firm can participate. For engineers that are long-time employee owners of the firm, the balance of your ESOP account can eventually become a significant portion of your overall net worth and often plays a key role in many of the strategies that may make sense to implement as you plan for retirement.

For that reason, it’s important to be mindful of the rules around ESOPs & how an ESOP may factor into your retirement plans. In this article, we’ll focus on many of those concepts, as well as addressing how Burns & McDonnell near-retirees can take steps to ensure they’re leveraging their ESOP account properly in retirement. Remember, if you have questions in the process of reading through this article, please don’t hesitate to schedule time with us to discuss your specific financial situation in more depth. Click here to schedule a no-obligation consultation.

In this article…

1. What is an ESOP?

2. The Alternative Ways to Think About ESOPs

3. What ESOP strategies should Burns & McDonnell engineers consider implementing?

 

1. What is an ESOP?

An Employee Stock Ownership Plan (ESOP) is a company ownership structure wherein employees own shares of the company. For engineering firms especially, these plans can be popular as there are a number of highly compensated employees, making the concept of having an ownership stake in the success of the firm particularly appealing. From the perspective of the employee owner, your shares of the company are commonly held in an individual investment account you can track over time. If the company is private, as many are, the value of your shares will typically be valued once a year, unlike publicly traded stocks that change value throughout the day.

2. An Alternative Way to Think About ESOPs

There are two important caveats that are important to remember about an ESOP when it comes to financial and retirement planning. To put both in very simple terms, diversification is key.

Your ESOP $1 ≠ $1

First is that your company stock is typically held in a pre-tax account. That means any stocks or cash in your account were contributed to the plan without any taxes being paid. When you see a balance of “$500,000” in your ESOP for example, it’s really more like $400,000. The reason is because when you eventually go to make distributions from that account (often after the ESOP has been converted to an Individual Retirement Account or IRA), you’re going to have to pay federal and state taxes on any amount you withdraw. Paying those taxes is going to impact your cashflow in retirement and should be a major consideration in your planning process. That’s why it’s important to diversify your holdings not just from an investment perspective, but a tax perspective as well. Focusing on building balances in accounts like Roth IRA’s or taxable brokerage accounts will allow you alternative places to take distributions from, thereby potentially lowering your tax bill in retirement.

Less Concentration

The second major caveat that should factor into your planning around incorporating your ESOP into your retirement plan is that as long as your ESOP is mainly composed of only company stock and cash, you may have a concentrated investment position and as a result, a higher amount of risk. That’s a difficult fact to consider if your company has been doing extraordinarily well for many years with consistent increases in the stock price over that same time. The reality though is that it only takes one bad year or one adverse economic or regulatory environment to cause that stock price to drop precipitously. Should that occur, suddenly a major portion of your overall net worth has declined and you may be limited on how long you’ll continue working to make up that decline. That’s why it’s important to diversify your holdings outside of just your ESOP, whether through your 401(k), Roth 401(k), Roth IRA or taxable brokerage accounts.

3. What ESOP strategies should Burns & McDonnell engineers consider implementing?

For several of the reasons mentioned above, the unique structure of your ESOP relative to your overall net worth typically necessitates additional considerations to be made in planning for retirement or being financially independent. Talking with a fiduciary, fee-only advisor is a great first step in determining whether it makes sense to implement any combination of the strategies below. Your financial situation is unique from anyone else’s and it’s important the advice you receive is custom to you & your family.

Cashflow Planning

The ability to look at what your cashflow will look like 5 to 10 years in the future is important once you transition from being an employee owner to being fully retired. Once retired, you’ll be living off a combination of your investments, your ESOP proceeds, social security, and potentially any other cashflow producing assets you may own like real estate, a side business, etc. Each of those is going to have unique considerations around risk, yield, tax implications, and diversification, so ensuring you’re incorporating all those elements in your cashflow analysis is important. When will you be receiving income? Will it be sufficient to cover your day-to-day expenses? How much cash should you have on hand? How can you take distributions from your accounts in a tax-efficient manner? These are the kinds of questions that cashflow planning can answer.

Tax Diversification

Since your ESOP is a pre-tax asset (again, no taxes paid yet), building a balance in other accounts can be advantageous from a tax planning perspective. Making contributions to a Roth IRA is a great way to start that process because it provides you the ability to create a tax-free stream of income later in retirement. Since your income is probably too high to contribute directly to a Roth IRA, remember you may be able to do what’s called a Backdoor Roth contribution where you fund a traditional IRA, then convert the amount over to a Roth IRA. There are also Roth conversions where you convert a portion of your IRA to a Roth IRA to take advantage of those tax-free withdrawals over the long term. Do these strategies make sense for you? The answer is highly contingent on your specific financial situation and what makes sense based on your goals and objectives over the long term.

Investment Diversification

One of the important keys to successfully investing over the long term is focusing not just on returns, but risk in your portfolio. Risk is often a metric that goes overlooked because it’s harder to quantify than the return you see on your account statement every month. It’s important to keep risk in mind though when investing and a specific type of risk common with an ESOP is called concentration risk.

You’ve likely heard the age-old adage to ‘not put all your eggs in one basket’. In investing, when you are holding a significant portion of your overall net worth in one investment, that’s called concentration risk. Whether you realize it or not, your ESOP likely exposes you to concentration risk as it only holds shares of Burns & McDonnell stock (unless you’ve diversified out of it). To attempt to reduce that risk, it may be beneficial to diversify your investments that are held outside of your ESOP or, after age 50 and 10 years as an ESOP participant, to diversify the holdings in your ESOP away from just company stock. In doing so, you move away from attaching your financial plans solely to the performance of one company and instead, spread out risk across a broad array of other investments.

When it comes to retirement planning or working towards financial independence, an Employee Stock Ownership Plan can bring some unique benefits and challenges. While an ESOP alone typically offers more pros than cons for the employee owners participating, having an ESOP may require some additional considerations to ensure it’s implemented efficiently as part of a larger financial plan. Curious to learn more about how your Employee Stock Ownership Plan fits into your overall financial plan? We’d love to chat.

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