September 13, 2011
This California fabricator finds success with its employee stock ownership plan. The ESOP gives everyone a stake in the business. ESOPs go against conventional wisdom in retirement planning, where the financial gurus promote investment diversification. But for LeFiell employees, investing in the ESOP has paid off--big time.
Butch Munson has had a long, good career at LeFiell Mfg. Co., a tube and specialty fabricator in Santa Fe Springs, Calif. He’s worked there for more than 40 years. Sure, the shop has had its ups and downs, but generally it has always found a way to do things better and faster. Recently the firm was bestowed with a Gold Supplier Award from Pratt & Whitney (see photo), a rare prize for a company employing only 100. And throughout the fabricator’s successes, the financial well-being of every employee, including Munson, has benefited. After all, they own the company.
LeFiell was launched in 1930 and, after decades of offering profit sharing and other employee incentives, became one of the 17 original companies to take advantage of what’s known as an ESOP, or employee stock ownership plan. As part of federal legislation enacted in 1974, an ESOP gives employees a stake in the business with retirement accounts consisting of company stock. Every pay period, an employee is given a certain amount that’s put into an ESOP trust, which is managed separately from the company. Once employees retire or otherwise leave the company, they receive the stock from the ESOP trust. If they worked for a private company (and most ESOP companies are private), the company is required to buy that stock and pay the employee its last valuation.
I called Munson, LeFiell’s manufacturing manager, after discovering the veteran fabricator had won the ESOP Association’s Employee Owner of the Year, an award he accepted in Washington, D.C., earlier this year. Munson is passionate about ESOP. He spells out the program’s benefits to anyone who asks. He even is willing to show younger employees his retirement account statements. He’s done well for himself, and he’s eager to show younger employees that they can do well for themselves too.
“I started here in 1967, so I’ve been in [the ESOP] every year since it started [in 1974],” he said. “I understand, when you start off as a young person as I was, you don’t care about retirement; just give me a paycheck. Then you get older and start having kids, and then the grandkids come, and you say, wow, this stuff is pretty good. And now I’m only a few years away from retirement, and I know it’s good stuff.”
In recent years some retirement planners haven’t looked too kindly on ESOPs, because they go against that most basic of investing principles: Diversify your portfolio. The skepticism is understandable, considering the corporate scandals of recent years. Many think you can’t trust your retirement to one company. The real world’s messy, they say, and even the best-run companies can fail for one reason or another. That’s why financial gurus tell us to reduce risk through diversification.
In 1986 the government did pass a law saying employees could diversify their ESOP retirement assets if they met certain conditions. If an employee has been with the company at least 10 years and is 55 or older, he or she can diversify a percentage of company stock purchased between 1986 and the present day, shifting that money to another retirement account, like an IRA.
At LeFiell, employees are also offered a 401(k). The company doesn’t offer any matching funds, but employees are free to contribute money, pretax, from their paychecks.
An ESOP’s stock price can fluctuate with the company’s business conditions. “We’re an aerospace company,” Munson explained. “We do parts for commercial aerospace, and even parts for the Space Shuttle. We’re up and down like a roller coaster every five or six years.” When the stock goes down, so does the value, so the urge to diversify is understandable, he said. In fact, Munson decided to diversify himself this year, putting some of his assets into an IRA. Shortly thereafter LeFiell’s stock reached its highest level ever.
Munson chuckled. “I’ve got great timing, don’t I?” (He did stress that even if he lost out on LeFiell’s stock gains by diversifying, he still will enjoy a very comfortable retirement.)
Such companies enjoy unique benefits under U.S. tax law. According to The ESOP Association President J. Michael Keeling, "One law in the U.S. permits an S Corporation ESOP company to pay no current federal income taxes if 100 percent owned by its ESOP."
He explained that in an S Corporation, shareholders are taxed, not the business. But in an S Corporation ESOP that's 100 percent employee-owned, even the ESOP trust—technically, the primary shareholder—isn't taxed for current earnings. Employees are taxed when they receive their ESOP account distributions after retiring or leaving the company. But as a business entity, an S Corporation ESOP, if 100 percent employee-owned, avoids paying current federal income taxes entirely.
He added that a private C Corporation ESOP also enjoys tax benefits, such as on capital gains and dividends—benefits that for some companies can be better than those of an S Corporation, depending on the situation.
Munson explained that as stockholders, employees have a right to know as much as they can about their primary retirement investment. For this reason, LeFiell reveals detailed financials to everyone. “Our CFO puts out a financial report, and it shows where every dime goes—even the amount we pay to the garbage truck that comes here to pick up our waste. The employees should know and have a right to know, because again, they’re stockholders.”
An ESOP shouldn’t be confused with an employee-owned co-op. As Keeling wrote in a recent article, “The worker-owned cooperative, or co-op model, has been in the U.S. for a long time as well. Technically, a co-op is not a stock company, and each employee has more or less equal ownership, and equal voice in selecting co-op leaders and managers. For many, the worker-owned co-op is the ‘true’ employee ownership model.” He added that though the model has worked, it tends to exist mainly in companies with fewer than 20 employees.
In an ESOP, employees are given a slice of the company in the form of stock, but that slice doesn’t mean managers give up control. What it does mean is that if the company does well, the employee benefits financially, so every person—from the front-office worker to the shop floor operator—has an incentive to improve. The smarter they work, the more financially secure they become.
“You have to think like an owner,” Munson said. “The more money you make for the company, the more money you get in your ESOP.”
All employees at LeFiell get 15 percent of their salary put into their individual ESOP accounts. The better an employee becomes, the more that person can climb the career ladder and get a better paycheck—which also means more money goes into the employee’s ESOP account.
Perhaps most important, when Munson retires from LeFiell, he’ll know exactly how his retirement investments became so valuable. He told me of a few efforts he’s spearheaded over the years—setup time reduction on forming presses and the like—that directly contributed to the bottom line and, hence, his investment portfolio.
This kind of investing isn’t about picking this stock or that mutual fund, and hoping in a few years or decades they will pay off enough to give you an enjoyable retirement. It’s about bettering yourself and providing more value for your employer; the better your employer does, the more valuable your stock. Come retirement, Munson likely will look at his financial statements and smile, knowing it was his hard work, and the work of his fellow employees, that got him there. And really, what could be more American than that?
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