Guide to Retirement Plan Options: Comparing ESOP vs. 401(k)

Employee ownership through ESOPs has proven to be a powerful tool – especially in competitive industries – for attracting and retaining top-tier talent. When employees have an ownership stake, they become more deeply invested in their company's success.

Many companies recognize this value and offer ESOPs in conjunction with other retirement benefits, such as 401(k) plans. In today's competitive job market, robust retirement benefits are essential to securing the best employees. That’s why business leaders going through succession planning often ask us which retirement option best suits their company's needs.

This guide provides a straightforward comparison between ESOPs and 401(k)s to help inform your decision-making process, including information about the ESOP rollover to 401(k).

What is an ESOP?

An Employee Stock Ownership Plan (ESOP) is an excellent benefit that enables employees to become owners in their company through company stock ownership. This structure not only incentivizes long-term employment but also allows employees to directly benefit from the company's success through their ownership stake.

Why should businesses consider this structure? Employee-owned companies demonstrate significant advantages, including lower turnover rates, increased employee satisfaction and productivity, and stronger financial performance compared to non-employee-owned peers. Additionally, since ESOP account values are tied to company performance rather than market fluctuations, they're not subject to the daily volatility that affects traditional stock market investments.

What is a 401(k)?

A 401(k) plan is an employer-sponsored retirement savings plan to which both the employer and employee can contribute until the employee reaches retirement age. The 401(k) earnings are not taxed until money is withdrawn from the account. 

Since these plans typically invest in mutual funds and other market securities, account values are directly correlated with the performance of the stock market. This exposure to market volatility can significantly impact retirement savings, particularly during economic downturns.

ESOP vs. 401(k): As a Qualified Retirement Plan

Both ESOPs and 401(k)s are qualified retirement plans, but they differ in their funding structure. While 401(k) plans are typically funded through employee contributions with employer matching, ESOPs are funded exclusively through company stock contributions. This means that in an ESOP, employees incur no out-of-pocket costs.

This distinction makes ESOPs particularly valuable for workforce demographics that might struggle with traditional 401(k) participation. Research shows that younger employees (under age 30) and those with lower salaries (below $40,000) often struggle to make regular payroll deferrals to a 401(k). In fact, one in four employees is missing out on their full 401(k) match. 

By providing retirement benefits without requiring employee contributions, ESOPs serve as both a powerful recruiting tool and a meaningful retirement benefit. ESOPs can build wealth for employees regardless of their ability to make personal contributions.

ESOP vs. 401(k): What Does it Mean for the Employee?

When comparing ESOPs and 401(k) plans, several key differences affect employee outcomes. Research shows ESOPs can deliver better returns for participants. According to a recent EY study, S corporation ESOPs demonstrated a compound annual growth rate of 12.1% from 2002 through 2019, which is approximately one-third higher than S&P 500 returns over the same period.

There are also tax advantages of ESOPs. Employee accounts grow tax-free until distribution, at which point participants have the flexibility to  roll their distributions into another qualified retirement plan, including a 401(k). This option allows employees to continue deferring capital gains taxes while maintaining investment flexibility.

Another notable distinction lies in contribution levels. While 401(k) employer matches typically cap at around 4% of employee contributions, ESOP company contributions often range from 6-10% of annual salaries, with no required employee contribution.

ESOP vs. 401(k): For the Business Owner

Unlike 401(k)s, where performance has no direct connection to benefits received, ESOPs create a clear link between company success and employee rewards. This alignment of interests often leads to stronger business outcomes and increased employee commitment. Because ESOPs create a work culture where everyone is invested in the company’s success, this elevated employee engagement can positively impact company performance.

Key ESOP Benefits for Business Owners

• Business owners maintain full managerial control while creating a succession plan that preserves their legacy.
• Employee interests align directly with company success, thanks to their ownership stake.
• Companies often offer ESOPs alongside traditional retirement plans like 401(k)s, creating a more competitive benefits package

When evaluating retirement options, consider that engaged employees are your company's most valuable asset. An ESOP creates mutual loyalty and shared purpose, because when employees become owners, they gain direct incentive to contribute to the company's success. This dynamic makes ESOPs a powerful tool for building lasting business value.

Common Questions About ESOPs and 401(k)s

Can an ESOP be rolled into a 401(k)?

Yes. Since ESOPs are qualified retirement plans, distributions can often be rolled into a 401(k) if the plan accepts rollovers. This allows employees to continue deferring taxes on their funds. However, if company stock is included, there may be special tax considerations, so it’s wise to review options before rolling over.

Can a company offer both an ESOP and a 401(k)?

Yes. Many companies offer both plans to maximize employee retirement benefits. An ESOP provides ownership opportunities, while a 401(k) allows employees to make personal contributions. Together, they can create a more competitive benefits package.

Which is better for employees, an ESOP or a 401(k)?

It depends on the employee’s situation. ESOPs offer ownership and potential higher long-term returns without requiring personal contributions, while 401(k)s allow employees to save independently and receive potential employer matches. Many employees benefit most from having both.

Aegis Trust: Your Trusted Partner in ESOP and Retirement Planning

Aegis Trust Company offers extensive experience in ESOP trustee services, helping businesses navigate the complexities of this ownership structure. We work closely with companies to ensure their ESOPs serve both business objectives and employee interests. Contact us today to schedule a complimentary consultation and explore whether our ESOP trustee services are the right fit for your company.