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Editor’s note: This is the second article of a six-part series about financial planning related to employee stock ownership plans (ESOPs), with a focus on getting the right financial advice for you, strategies for diversifying and preparing for retirement. Part one is Why High-Net-Worth Families Need a Financial Quarterback to Protect Their Wealth.
Imagine you’re 60 years old with $800,000 in your employee stock ownership plan (ESOP). Your company’s stock has climbed 40% over the past three years. When you have the opportunity to diversify, you decide to wait. After all, why sell shares when they’re performing so well?
Then disaster strikes. An unexpected event triggers a catastrophic 60% decline in your company’s stock value. Your $800,000 ESOP balance plummets to $320,000.
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Instead of retiring at 62 as planned, you’re now facing a decade of additional work to rebuild what you’ve lost.
This isn’t just fear-mongering. This is exactly what happened to ESOP participants at Silicon Valley Bank (SVB).
In March 2023, SVB went from announcing a $1.8 billion loss to watching $42 billion flee in bank runs to federal takeover in just 48 hours. Employees who’d been riding high on company stock watched their retirement plans disintegrate faster than they could process what was happening.
Here’s the reality: When you’re holding concentrated company stock and you have the ability to diversify, waiting because “things are going well” may be one of the most expensive mistakes you’ll ever make.
Understanding your diversification rights
ESOP participants have specific diversification opportunities designed to help reduce concentration risk as retirement approaches. Once you reach age 55 (with at least 10 years in the plan), you can begin moving up to 25% of your ESOP into other investments all at once or over a five-year period.
Then at 60, you can diversify up to a total of 50%. This means if you’re 60 and have never diversified, you could potentially move half of your ESOP holdings into other investment vehicles.
Here is an example. If you have a $600,000 ESOP balance at age 55, you could move $150,000 out of company stock and into something more balanced, such as an IRA with a stock or bond mutual fund. At 60, you could diversify another $150,000. That’s half of your retirement savings protected from company-specific risk.
Many ESOP participants make costly mistakes because they don’t understand the specific timing rules for diversification. There are limited windows with firm deadlines.
After you become eligible for diversification, you typically have a 90-day window following the plan year to notify your company that you want to diversify. Miss this window, and you may have to wait another full year.
This means you need to know your plan’s schedule. Check with your ESOP representative to understand these critical dates. They’re not negotiable, and missing them could prove costly.
The distribution deadline: Another layer of complexity
After you elect to diversify, there’s another potential delay to receiving your payout. Companies have up to 180 days to actually distribute your money. So if you’re counting on those funds for something time-sensitive, build in that buffer. I’ve seen people caught off guard by this delay, assuming the money would show up in weeks, not months.
For example, if you elect to diversify $200,000 at age 60 in January, you might not receive those funds until July or later. This gap could affect other financial decisions you’re making.
The Kodak story: When waiting becomes devastating
Kodak dominated photography for 131 years. Employees believed in that legacy, maybe too much. Even as digital cameras ate into their market and the company clung stubbornly to film, ESOP participants held on. Surely Kodak would figure it out, right? The company had survived everything else.
By January 2012, Kodak filed for bankruptcy. People who could have diversified 50% of their accounts at 60 watched those shares become essentially worthless. The cruel irony? They had time.
Unlike SVB’s 48-hour implosion, Kodak’s decline unfolded over years. Participants could see the problems. But seeing problems and acting on them are two different things, especially when it means acknowledging that the company you’ve built your career around might not make it.
Your diversification roadmap: Actionable steps
Understanding these rules matters, but taking action matters more. Here’s your road map for navigating diversification opportunities:
Immediate actions:
- Review your ESOP plan documents to understand your specific diversification schedule, election windows, and distribution timelines
- Calculate your current diversification eligibility based on your age and years of participation
- Mark your calendar with upcoming 90-day election windows so you don’t miss critical deadlines
- Assess your current concentration risk. What percentage of your total retirement assets are in company stock?
Strategic planning:
- Consider diversifying the maximum allowable amount at each opportunity rather than waiting for “better” timing
- Coordinate diversification elections with your overall retirement income strategy and tax planning
- Plan for the potential 180-day distribution delay when making financial decisions
- Work with a financial adviser experienced in ESOP diversification rules
Ongoing management:
- Review your diversification strategy annually
- Don’t let strong recent performance convince you to delay prudent diversification
- Remember that you can’t time the market or predict company-specific events that could devastate concentrated holdings
Take action before your window closes
The participants at Silicon Valley Bank and Eastman Kodak didn’t lack intelligence or financial sophistication. What many lacked was a clear understanding of their diversification rights and the willingness to act when those windows opened.
Your ESOP represents years of hard work and dedication. Transforming concentrated wealth into reliable retirement income requires understanding the diversification limits, timing windows and distribution deadlines that govern ESOPs.
This strategy may help preserve your retirement timeline and reduce the concentration risk that has derailed countless retirement plans.
If you’re approaching age 55 or 60 with substantial ESOP holdings, don’t wait for a crisis to think about diversification. The time to act is when you have options.
For readers looking to better understand how ESOP strategies apply to their own situation, Peter Newman created My ESOP Planner — a resource focused on helping employee-owners plan for diversification, retirement income and legacy decisions. Learn more at www.myesopplanner.com.
