Cale Flage, CFP®

Cale Flage, CFP®

Cale Flage, CFP®

Financial Advisor

Should I diversify my ESOP?

If you work for a company that offers an ESOP (Employee Stock Ownership Plan) you may be asked if you want to diversify a portion of your company stock. You may wonder if this is a good idea and the answer is, in most cases, yes!

An ESOP is a great benefit from your employer, but if you stay at a company long enough you may end up with a significant amount of your net worth tied up in your employer’s stock. This can be great if your company continues to grow and the stock price continues to increase. However, having a large concentration of employer stock could leave you exposed to big losses if things go wrong. 

Many Kodak employees were able to participate in an ESOP. At one time, Kodak was the 5thmost valuable brand in the world. Kodak was responsible for 90% of film sales and 85% of camera sales in the United States. The company invented the digital camera and the OLED screen.  Owning shares of such a dominant company surely seemed like a wise decision. Unfortunately, Kodak declared bankruptcy in 2012 and shareholders experienced extreme losses. 

To help avoid situations like Kodak, the IRS requires ESOP plans to allow employees to diversify a portion of their holdings once they reach a minimum eligibility requirement of age 55 and 10 years of participation in the plan. Your employer is permitted to have more generous qualifications.

Once eligible, it could be a great idea to sell the stock and roll the cash into your company’s 401k plan or an IRA and diversify. Generally, diversification is a great, but it doesn’t guarantee against loss. However, you do eliminate the risk of your entire investment being wiped out permanently if your company were to go bust.

The Details:

  • To qualify, you must be 55 years or older and participated in the plan for 10 years, although your employer may have a more generous policy.
  • You have a “qualified election period” to diversify from the ESOP plan, which is a 6 “plan-year” period starting when you become qualified.
  • You can diversify 25% of your shares in the first 5 years, and 50% in the 6thyear.
  • All shares of stock diversified are included in calculating the number of shares available for diversification in following years. See example:

1st qualifying year

# of shares of stock in first qualifying year:800
Diversify 25% of shares of stock.x .25
Number of shares sold and diversified:= 200 

6th qualifying year

# of shares in 6thqualifying year (increased due to continued participation in the ESOP)1,000
For calculation, add the 200 shares previously diversified+ 200
Diversify 50% of shares of stockx.50
Subtract 200 previously diversified shares-200
400 shares can be sold and diversified=400

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