ESOP Explained: The Differences Between an ESOP and a 401(k)

by TMC Corporate Communications on Thursday, October 19, 2023 in ESOP

An employee stock ownership plan (ESOP) and a 401(k) both serve the same basic purpose: they help employees save for retirement and build wealth. But these two types of retirement plans are different in some key ways—and, as an employee-owned company, TMC feels that an ESOP offers some unique benefits for employees.

Read on to learn more about the distinctions between a 401(k) and an ESOP and answer some important questions about each type of retirement account.

Who contributes to the account?

In an ESOP, company shares are allocated to each employee who meets certain minimum requirements—without any cost to the employees—and held in a trust. In a 401(k), employees make contributions from their pre-tax salaries into an account, and companies may match some percentage of their contributions.

How much is contributed?

ESOP companies generally make contributions worth about 6 to 10 percent of an employee’s salary to their ESOP account per year—and TMC’s contribution rates are usually higher than this. On the other hand, the average employee’s contribution to their 401(k) is 7 percent of their salary, before any employer matching.

Where do contributions go?

401(k) accounts are often invested in mutual funds, which are a collection of stocks, bonds, and securities. These funds are often designed to be low risk, but their value can still change significantly with the rise and fall of the stock market. Because an ESOP account holds shares in just one company, as the company performs well and the share price increases, employees see an increase in their ESOP account. What’s more, employees feel a sense of ownership because their hard work helps the company—and their ESOP account balance—grow.

What is the average rate of return on the account?

The return on an ESOP account varies from company to company, but according to a study by consulting firm EY, the average annual rate of return for an ESOP account was about 12 percent between 2002 and 2019. Over its first 10 years as an ESOP company, TMC’s average share price growth (and the growth of individual ESOP accounts) exceeded this rate most years. For a 401(k), the average return depends on the stock market and is usually 5 to 8 percent. In light of this, it’s no wonder that employees at ESOP companies typically have about twice as much in their retirement accounts as their counterparts at other organizations.

Not all US companies opt to offer retirement plans to their employees, and of those that do, few offer an ESOP. Here at TMC, we’re proud to work for an organization that helps all employees save for their retirement and build wealth by giving employee-owners a share of the company’s growth and success.