Updated: Feb 17
As an employee owner, you have a handy wild card in your retirement planning portfolio – your ESOP. This nest egg has been your incentive to help the company grow and become the success it is today while promising you a slice of the pie at retirement.
Your employee owned stock is concentrated on the success of one company. As you near retirement, it is important to reduce the risk in your accounts. This is where diversification comes into the picture.
The Risk of Concentrated Stock
As a single concentrated stock, the value of your company stock can fluctuate wildly. And fluctuation is something that can be very good or very bad. These swings in value cannot be timed to align with your retirement.
I’ve seen many individuals retire from employee owned companies with great success, but at the same time – before the IRS required ESOP plans to allow employees to diversify a portion of their stock – I think of Kodak. Kodak was a giant, the 5th most valuable brand in the world. And, it was an employee owned company that declared bankruptcy in 2012. Imagine the struggle those employee-owners faced losing their retirement stock and their jobs at the same time.
No matter how well your company stock is doing, it should not be your only retirement savings. Be sure to have a comprehensive financial plan that includes multiple sources of retirement income.
A little preparation – in the form of an Individual Retirement Account plus regular 401k contributions of at least 10% of your salary each year – now could save a lot of heartache later. Reduce your investing risk by including a portfolio of diversified stock, bonds, and real estate mutual funds in your retirement nest egg.
Your Diversification Opportunity
If you are close to retirement, you may be wondering what to do with your ESOP. During your tenure, your company has been rewarding you with shares annually. At the beginning, your ESOP balance looked small. But it grew. And now you are on the cusp of your diversification opportunity. ESOP companies offer diversification at age 55 and 60 before your retirement.
This means you can sell 25% of your stock back to the company and receive cash. You can spend that cash or roll it over to your retirement account. The retirement account could be a 401k or an Individual Retirement Account (IRA). If you spend the cash, you will owe taxes.
To avoid IRS penalties and maximize compounding value to your retirement, diversify ESOP stock with your IRA account at age 55.
When you invest the cash from your ESOP stock in your retirement account, consider purchasing a diversified portfolio of stocks, bonds, and real estate funds. <<link to blog post on diversification that references investments/gardening>>
Grow Your Retirement Nest Egg
The graph below illustrates what could happen if you have $1,000,000 in your ESOP when you are 55 years old with at least 10 years of ESOP participation. It demonstrates a participant who sold shares back to the company at every opportunity and moved the cash into a tax deferred IRA between ages 55 and 68. Your company’s schedule may vary from the one shown below. Ask your human resources person or consult your plan document.
The ESOP participant was able to grow his ESOP balance from $1,000,000 to nearly $2.5 million. He took diversification at 55 and 60. Then, upon retiring at age 64, he took distributions of the remaining balance across 5 years. At each of these points, the cash was moved into an IRA. During these 14 years, the company share price continued to increase by a few percent each year and the IRA returns increased by 6%. These are assumptions, not guaranteed, and your personal company stock and IRA account will vary.
How much income?
In our example above, a $2.5 million IRA nest egg could generate an estimated $75,000 to $100,000 in annual income before tax. This will depend on the mutual funds you invest in with your financial advisor and your chosen withdrawal rate. If you purchase an annuity you may be able to enjoy even higher income.
Defer paying taxes today.
By moving your ESOP cash into an IRA, you will not be taxed on it until you begin to take withdrawals. This means your nest egg will continue to grow tax deferred. So monies that would have been directed to Uncle Sam stay in your investment account for additional years and earn compounding interest. The longer it is there, the more it should grow.
Forecast your income.
Forecasting how large your investment accounts could be at retirement helps you to understand if you are on track to meeting your income needs at retirement. Your goals may include traveling, spending more time with family, helping your children or grandchildren with an important milestone like college or a wedding, or creating a legacy within your estate plan.
Whatever your goals, forecasting today can help you make adjustments to improve your chances of success.
Are you comfortable with your progress towards retirement? How about helping future generations meet their financial goals?
Peak Wealth Planning meets with clients in Champaign and Chicago, Illinois, as well as in Colorado near Denver, Winter Park, and Fraser.
If you have a net worth over $2 million and need help from a wealth manager, the Peak Wealth Planning team can assist you.
Peak Wealth Planning specializes in helping high-net worth individuals and families plan for the future.
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About the Author
Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.
Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning advice. Peak Wealth Planning is a fee-based financial advisor based in Champaign, Illinois, and Fraser, Colorado.