When you’re searching for a new job, a key component of your evaluation involves a company’s benefits package. Because employers want to attract—and retain—talent, offering a good benefits package goes a long way. Perks like healthcare insurance, retirement plans, and even an office gym can definitely sway people to come on board with an employer.
Some benefits work to attract talent as well as align the interests of the company’s employees with its shareholders. One way employers do this is by offering an Employee Stock Purchase Plan (ESPP). Many of our clients that have these plans available to them wonder if they should participate. Let’s discuss the basics.
Employee Stock Purchase Plan Basics
Put simply, an ESPP allows you to purchase company stock, usually at a discounted price. Your employer will make it easy for you by automatically and regularly withdrawing money from your paycheck to finance your purchases of company stock.
During the “offering period” of your ESPP, you accumulate payroll deductions; then during the “purchase period,” those deductions are used to effectively purchase company stock at a discount of 15% or less. During a given year, the maximum amount of capital an employee can invest in their company stock through their ESPP is capped at $25,000.
To preserve favorable tax treatment, an employee must refrain from selling the stock for at least 2 years from the start of the “offering period,” and 1 year from the date in which the shares were purchased. Both conditions must be met.
Why Should I Participate in an Employee Stock Purchase Plan?
The most obvious benefit of the ESPP is that you can get stock shares at a discounted price. The discount varies by plan and can be as high as 15%. Some plans even offer a look-back provision that makes it possible to get an even steeper discount if the stock price has gone up during the offering period. In addition to the price discount, you don’t have to pay commissions on the purchase, which saves you even more.
Discounted prices can also help you earn money right away if you choose to sell your positions as soon as possible. If you purchase a stock at a discounted price and turn right around and sell it for market price, you will have earned the difference between the selling price and discounted price (although these earnings will be taxed at a higher rate than if you held your position long-term). Usually, about 15% of employees will participate in their company’s ESPP and sell as soon as they are eligible to create supplemental cash flow.
An ESPP makes investing easy. All you have to do is tell your HR department how much you want to invest and they take care of the rest. You get automated, regular investments in a company with which you are already familiar.
Potential Tax Advantages
If your ESPP is a qualified plan, as most are, then you can receive preferential tax treatment. You realize these benefits upon the disposition of your company shares. As mentioned above, holding periods and certain other rules must be followed to receive these tax benefits, so you need to become familiar with your specific plan before taking action.
Why Should I Avoid an Employee Stock Purchase Plan?
The major risk associated with participating in ESPPs is the potential loss of the benefits of diversification. Over time, as an employee accumulates large amounts of stock in the company, they effectively create a concentrated investment position that can solely dictate how their financial future unfolds. When the company experiences hardships, so will you.
Taken to the extreme, should the company experience so much hardship that you lose your job, not only will you lose your source of income, but your investments may take a hit as well. When you need the money the most, it’s gone.
While they do offer some nice benefits, ESPPs also carry a high degree of concentration risk that can expose individuals to unforeseen risks of substantial proportions.
When purchasing an ESPP within a 401(k), your company might place restrictions on your ability to buy or sell the stock or transfer it to another type of investment within your retirement plan. Employer-matched stock, in particular, often comes with restrictions. Some companies require employees to hold the stock until they reach a certain age, or until a specified date. Lockdowns or blackouts (periods, usually short, in which account activity is frozen, generally to perform administrative tasks) can also occur. While prior notice is generally provided, the timing may coincide with market volatility, potentially resulting in a loss.
Questions to Ask Yourself
Do I need this money now?
While saving money for the future is important, it may not be a practical reality for all. If you have prioritized paying down debts, or simply require the funds to provide for daily expenses, ESPP investing may not be a viable option.
Is my company really the best investment out there?
The capital markets offer a staggering amount of options for which to invest your money. What are the odds that the company you work for is the very best option out of them all? You are already working hard on a daily-basis for the betterment of the company; it’s important to remember you are under no obligation to invest your hard-earned money there as well.
We Are Here to Help
Financial decisions depend on your unique financial situation and goals. So while an ESPP can be a great opportunity, participating in yours may or may not be the wisest move. This is where a qualified professional can help you better understand your financial picture and arrive at a decision that is right for you.
At Center for Wealth Management, we specialize in simplifying complex issues and can help you make decisions with confidence in order to maximize your benefits and ultimately create a retirement plan you can rely on. Reach out today to schedule a free introductory meeting online, call (248) 220-4321, or email me at firstname.lastname@example.org.
Justin Williamson is a senior partner and co-owner of Center for Wealth Management, an independent, fee-based wealth management company in Troy, Michigan. Justin has been serving clients in the financial services industry since 2001. He spends his days helping his clients achieve their financial goals and make the best decisions for their families so they can spend time on what they love and experience financial peace of mind. Justin is known for his dedication, integrity, personal touch, and ability to simplify complex issues. Justin specializes in serving engineers and other professionals who are close to retirement or recently retired and helping them maximize their benefits and create a retirement plan they can rely on. He is a seasoned public speaker and presents at numerous corporate events each year on retirement planning, Medicare, Social Security, and other financial topics. Justin has a bachelor’s degree in Business Administration majoring in Personal Financial Planning from Central Michigan University and is a CERTIFIED FINANCIAL PLANNER™ practitioner.
Outside of work, Justin enjoys spending time with his family. He lost his wife of 18 years, Heather, to brain cancer in 2020. He and his son, Carter, and twin daughters, Jaden and Kelsey, work to honor her and make her proud each day. Outside of work, you can usually find him coaching baseball, softball, and basketball, and spending time at their family cabin at Higgins Lake. Learn more about Justin by connecting with him on LinkedIn.