There’s a reason your employer offers you a benefits package; it’s an incentive for you to stay with the company and a reward for your hard work and loyalty. Plus, if your employer can align your financial well-being with that of the company, it’s a win-win for everyone. One way employers do this is by offering an Employee Stock Purchase Plan (ESPP).
In a nutshell, an ESPP is your employer allowing 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.
The most obvious benefit of the ESPP is that you can get stock shares at a discounted price. The discount varies by plan but 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 considerably during the offering period. If an employee invested the maximum allowable amount of $25,000 into their ESPP under the max discount of 15%, they would effectively own $29,411 of company stock, despite having only paid $25,000 for it. An extra benefit of $4,411 a year.
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 that you are already familiar with.
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. Certain rules must be followed to receive tax benefits, so you need to become familiar with your specific plan before taking action.
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, as 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 are likely to evaporate along with it. When you needed the money the most, it was gone.
While they do offer some nice benefits, ESPPs do carry a high degree of concentration risk that can expose individuals to unforeseen risks of substantial proportions.
When purchasing 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 in which account activity is frozen, generally to perform administrative tasks, usually for a short period – can also occur. While prior notice is generally provided, the timing may coincide with market volatility, potentially resulting in a loss.
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.
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 is important to remember you are under no obligation to invest your hard earned money there as well.
While an ESPP can be a great opportunity, whether or not you should participate in yours depends on your financial situation and goals. A certified professional can help you better understand your financial picture and arrive at a decision that is right for you.
So, let’s have a chat…
We at Wealth Advocate Group would be more than happy to help! Call 440-505-5704 or email jbrown@Wadvocate.com to schedule an introductory appointment.
John D. Brown is a Partner and CERTIFIED FINANCIAL PLANNER® (CFP®) at Wealth Advocate Group, LLC – an independent, fee-based wealth management company. With over 10 years of experience in the financial industry and an extensive background in accounting, John provides specialized services to senior executive clients who would like assistance managing their concentrated securities, stock options, restricted stock, as well as aid in managing the risks and tax burdens associated with their compensation. John has a bachelor’s degree in accounting and financial management from Hillsdale College. To learn more about John, connect with him on LinkedIn.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
Wealth Advocate Group and LPL Financial do not provide tax advice or services. Please consult your tax advisor regarding your specific situation.
