KSOP Retirement Plan – All you need to know

by Sarath | August 25, 2020

With all the uncertainties in the market these days, many businesses struggle to keep up with their retirement savings plan as they recover from the economy. What seems so far off in the distance can be hard to grasp for the here and now. However with more time to clear the company backlog, now is a good time to start researching on ways to set up a successful retirement plan for your company.

There are different types of employer sponsored retirement plans such as SIMPLE, SEP, ESOP, 401(k), and others. Each of these plans are designed to cater to a certain type of employment or industry. And each one of these are governed by federal regulations that dictate their investment limits, vesting schedules, and operating terms with the stakeholders.

A KSOP (Combination of 401(K) and ESOP) is one such popular retirement savings plan. A KSOP plan has evolved over time when companies realised the benefits of combining two different plans and streamlining their profits. In this article we will focus on KSOPs and try to understand the pros and cons of this scheme as well. Let us begin.

KSOP

Broadly speaking, there are two types of retirement savings: a defined benefit plan, which is a traditional employer sponsored pension scheme, and a defined contribution plan, which employees fund with their own money, have complete ownership, and receive special tax benefits. A KSOP retirement plan is a defined contribution plan, and being a combination of two plans, it helps the company reduce expenses of operating two plans separately. Let’s investigate more.

What is KSOP Retirement Plan?

Employee Stock Ownership Plan (ESOP) invests employee contribution in stocks of the company. A 401 (k) plan, named after the tax code governing it, is a retirement account to which employees contribute part of their salaries on a tax deductible basis normally in diverse mutual funds. In a 401(k) plan, an employer can sometimes choose to provide a matching contribution not exceeding 3% of the pay. A KSOP Retirement Plan combines the benefits of ESOP and 401 (k) plans.

Through this combination plan, participants and sponsors enjoy special tax benefits. Employers also create KSOPs to improve the sense of company ownership among employees, albeit their ownership is still subject to market risks.

How does KSOP Retirement Plan Work?

Since KSOP is a combination of ESOP and 401(k) plans, the company will match employee contributions with their own stock rather than cash. Companies can offer their own stock as employee benefits and when required, move them around between these two plans. This would not be possible if the company offered ESOP and 401(k) separately because assets invested in each one will stay limited to that plan only. Thus, a KSOP plan not only creates a profitable marketplace for company shares, but also ensures ease of liquidity.

Investing in KSOPs motivates employees to contribute better towards making the business profitable. This way, the share price of the company increases, and in turn enhancing the value of the retirement plan. However, the actual benefit of the KSOP Retirement Plan will depend on the amount contributed by the employee, the company’s matching contribution if any, and the market performance of company shares.

KSOP: Combining ESOPs and 401(k) Plans

Most companies that offer ESOPs to their employees also sponsor stand-alone 401(k)s. Employees have to carefully choose how much and in which plan to invest, as money invested in one plan cannot be moved to another. The amount contributed to an ESOP will stay limited in it even if the company’s stock price plummets. KSOPs change this condition.

A KSOP Retirement Plan creates a flexible scheme where employees are not limited by their investment choices. Since it combines the benefits of ESOP and 401(k), based on share prices, money can be moved between the two plans. This makes it easier for employees to streamline and understand their investment choices.

However a KSOP document must clearly specify the ESOP portion, as all rules of stand-alone ESOP will apply on this portion. An ESOP is best utilized in publicly traded companies. But sometimes the employees may choose to invest their 401(k) match in the company stock as well.

Pros and Cons of KSOP

A typical investment portfolio involves varied options such as cash, bonds, stocks and other money market instruments. But a KSOP limits investments to company shares without distributing the risk over different asset classes. Benefits could sway in either direction. Even though a KSOP houses benefits of two popular retirement plans, it is important to understand the flip side as well before signing up for one. Here are some pros and cons of KSOP retirement plans:

Pros of KSOP

With ESOP and 401(k) benefits combined in a KSOP Retirement Plan, employers can provide higher benefits to the employee at a minimal cost to the company. Taxes saved from the ESOP, when applied to the employee benefits program, increases the overall value of the benefits program. An employer can choose to funnel the saved funds as a matching contribution to the 401(k) or any other plan.
KSOP provides a holistic view of the hybrid benefits. Employees can see the bigger picture and understand the flexibility of investments provided by this combination. The cumulative sum in savings is much larger than the individual plans, which are good motivation for employees.
Combining ESOP and 401(k) into a KSOP retirement plan reduces cumbersome paperwork for both the employers and employees. Companies can also avoid paying extra (for IRS user fees and other large plans related to annual accounts) separately for each plan.

Cons of KSOP

If the company is not publicly traded, agencies and trustees willing to handle 401(k) plans components of the KSOP may step back fearing to handle employer securities. Valuations based on company stock prices can be volatile.
In KSOP retirement plans, there is a healthy contribution to the ESOP component. Hence some companies may levy strict eligibility criteria such as vesting schedules, ESOP distribution timing, and the likes. Communicating these varied restrictions to the employee may complicate clarity.

From an employer’s perspective, if efficiently planned, a KSOP’s positives stand to outweigh the negatives. It is also better for an employee to receive benefits in a consolidated manner, as it will give them a broader understanding of the bigger picture. The accrued expenses from the combination of two plans will be a chunk in comparison to the benefits from an ESOP and 401(k) separately.

A KSOP Retirement Plan is a novel combination of the two most opted retirement plans, but many other employer-sponsored schemes are available. Narrowing down to the best option depends on factors like company size and economic sector. Based on their needs, it is beneficial for the employer and employee to opt for one of these schemes.

Other Popular Employer-Sponsored Retirement Plans

One of the biggest advantages with retirement plans is that during their service period, savings are directly deducted from the employee’s salary component without having to be channeled separately. There are enormous tax benefits as well. If the employer chooses to match contributions, that’s also a bonus. Here are some popular employer sponsored retirement plans apart from KSOP:

SIMPLE Plan – Savings Incentive Match Plans for Employees (SIMPLE) is an IRA Plan. It is suitable for small companies with 100 employees or less. Employees will make tax deductible contributions. The employer can either choose to make a 2% compulsory contribution to retirement accounts of all employees or choose to match employee contributions up to 3% of the pay. As of 2020, an employee can contribute a maximum of $13,500 annually to a SIMPLE Plan. If the employee is participating in other retirement savings plans such as KSOP, as of 2020 total contributions must not exceed $19,500.
SEP Plan – Simplified Employee Pension Plan (SEP) is based on an IRA and is better known as a SEP-IRA plan. Unlike KSOP Retirement Plans of corporate accounts, this plan is best suited for self employed individuals such as freelancers, writers, consultants, and others. Rules of traditional IRAs apply, but contribution limits might be much more generous. On behalf of eligible resources the company may choose to make tax-deductible contributions to this account and claim the tax deductions as well. But the contribution has to be the same for all employees. With an SEP plan, the maximum an employee can contribute to all retirement plans combined is $57,000 in 2019.
Roth 401(k) plan – This plan offers benefits of a regular Roth IRA plan. Employee contribution limits are similar to 401(k) plans, which is much more generous than what Roth IRA plans allow. But unlike a 401(k) plan, taxes are paid on the contribution and not withdrawals. Money thus grows free of tax and income tax need not be paid during withdrawals. Minimum distribution rules of 401(k) plans apply. Employees have to start withdrawing money from this account once they hit age 70 ½. Unlike a KSOP combination plan, if an employer offers both Roth 401(k) and 401(k) separately, an employee can invest savings in both plans as long as the combined annual contributions does not exceed $18,500 as per the 2018 guidelines.
403 (b) plan – This plan is identical to a 401(k) except that it is prescribed for non-profits and other tax exempt groups like schools, religious institutions, hospitals, etc. This plan is funded primarily by employees with contribution limits similar to 401(k) plans. Employers can match contributions to a certain percentage. But most often, unlike in KSOP retirement plans, employers choosing 403(b) plans do not have sufficient income to afford matching contributions. All earnings of the employee accumulate on a tax-deferred basis, and vesting is usually immediate.
457 plan – This plan is also similar to 401(k) and is offered to state and local government employees. Employee contribution limit is the same as a 401(k) plan. But there is one big difference which is not offered to any other plan including KSOPs. If an employer chooses to offer both 401(k) and 457 plans, employees can contribute to the maximum limit in both plans simultaneously. Hence as per 2020 guidelines, an employee can contribute a maximum of $19,500 to each plan and create a savings of $39,000 for retirement.

Retirement plans are part of a company’s work culture. After employees retire, it is natural for them to expect a benefits package which will take care of their financial needs when they no longer hold a regular job. Hence employees are attracted to companies who provide well thought out retirement plans no matter which business they are into. Receiving equity as retirement benefit turns out to be profitable most of the time in comparison to cash packages.

Conclusion

Retirement plans have undergone a lot of changes over time. Investing money in the company stock is never an easy judgment. Since KSOPs allow the movement of money between the ESOP and 401(k) components, employees have to be careful about deciding how much money to invest in and when to streamline or distribute funds. It is best to work closely with a financial advisor. If you want to start issuing and managing shares in an automated way, try out our Eqvista App. It is free (for small companies) and all online!

Eqvista’s sophisticated software enables companies, investors, and company shareholders to track, manage, and make intelligent decisions about their companies’ equity. Planning equity for retirement benefits becomes easier, quicker, and less cumbersome. If you want to know more or understand any other process, check out these support articles or contact us today!

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