Strike a match: offering company stock in your 401 plan can be risky business—learn how to avoid getting burned when playing with matches

Entrepreneur, April, 2005 by C.J. Prince

MATCHING employee contributions in company stock in a 401(k) plan sounds like a surefire move. You gain a competitive tool for attracting and retaining talent and give employees more of a stake in the company's future success. At the same time, you give your share price a boost and get a tax break on the contribution without having to tie up precious cash.

"I think it's an excellent idea--if you know why you're doing it," says Jeff Robertson, attorney with Portland, Oregon, corporate law firm Bullivant Houser Bailey PC. But too often, he says, business owners are motivated by the tax break and fail to protect themselves from the fiduciary risk.

The biggest problem, notes Rick Meigs, president of 401khelpcenter. com--also in Portland--is that a built-in conflict of interest exists for companies offering their own stock in their 401(k) plans. "They have to run the retirement plan exclusively for the benefit of participants and retirees," he says, "but the very next minute, they're trying to protect the company when [there's] bad news." That forces a tough choice: Give employees the information they need to adjust their portfolios to their benefit, or withhold bad information to keep the company stock steady. Meigs adds that trial attorneys are beginning to zero in on this issue, looking for class-action cases. Though the lawsuits typically target larger corporations, smaller companies are still at risk.

One way to shield your company is to hire an independent ERISA (Employment Retirement Income Security Act) fiduciary to handle plan operation and asset investment. That way, Meigs says, you "take the responsibility away from those who have an inherent loyalty to the company." Another option is to provide training for your CFO on how to manage the plan according to ERISA standards.

On the employee side, more and more plans are being amended to allow employees to divest out of matched company stock sooner and with fewer restrictions. And many plans now cap the amount of employer stock they allow in a company's 401(k) plan. To protect yourself further, Robertson advises carefully documenting communication with employees about the company stock and plan rules.

Private companies that want to offer a match in stock have additional challenges, including lack of liquidity since there's no market for the stock. And owners must also ensure proper valuation of the company's stock, which can cost between $5,000 and $25,000 a year to assess.

Given some of the risks of offering a match in company stock, many experts advise entrepreneurs to forgo matching in company stock and match the contributions in cash instead. Though business owners balk at the expense, it probably costs less than you think, says Trisha Brambley, president of Resources for Retirement Inc., a Newtown, Pennsylvania, firm that helps companies evaluate funds and fees involved in retirement plans. Say, for example, you set up the plan to match 25 cents per dollar on the first 4 percent employees contribute. Not every employee will be eligible or will defer the whole amount. "So the actual cost of the match is pretty small, maybe half a percent of payroll," says Brambley. And you get the tax break on the cash match just as you would with company stock.

Plus, the higher-paid employees, including owners, can defer more income--2 percent more on average--than the rest of the work force. So the more people who sign up, the more pretax income the owner can shield. That's why Brambley says you should offer a match, even if it's going to mean some out-of-pocket costs. And a cash match, she says, will often double employee participation in the plan.

If you still want employees invested in company stock, the best way to do it, at a much lower risk, is with a good, old-fashioned employee stockownership plan. It's not a tax-saving vehicle, but you'll be giving employees more skin in the game while keeping your company out of court.

C.J. PRINCE is executive editor of CEO Magazine. She can be reached at cjprince@chiefexecutive.net