An ESOP consultant discusses a strategy to make the most out of cash set aside to cover the stocks.
Businesses with employee stock ownership plans face a quandary: they need to build up enough cash to buy back stock when employee owners resign or retire. Some companies with ESOPs respond by keeping spare cash in such safe, liquid investments as bank certificates of deposit.
But that can be a costly mistake, says Jim Simpson, president of the ESOP Group of Ohio, a Cincinnati-based consulting firm. One of his clients, for example, a construction company whose stock value was recently appraised at $15 million, kept $9 million in CDs at a local bank, earning just 3% in annual interest after taxes. "Invested wisely, that money could have brought much more to the bottom line," Simpson asserts.
His suggestion: ESOP companies can take out variable life-insurance policies on key employees "and use the cash buildup in those policies to invest" in blue-chip stocks or stock mutual funds. If companies follow the regulations spelled out in the tax code, investments made within the variable life policies will be given tax-free treatment. And there's another benefit: since the insurance policies are owned by the company itself, proceeds pass back to the company upon the employee's death.
The strategy must be studied to be understood, but it can help companies with ESOPs accumulate the cash they need. It could also make sense for non-ESOP companies that generate significant amounts of excess cash. Check with your financial adviser.