Every employer has the goal of recruiting and retaining quality talent. An Employee Stock Purchase Plan (ESPP) is a great way for employers to attract and hold on to skilled employees, while also aligning the interests of those employees and shareholders. This type of incentive package may include healthcare insurance, retirement plans, and other perks like an office gym. These benefits not only help draw in talented individuals but can also keep them engaged with the company. Read on to hear thoughts from our team at Grace Wealth Management Group to understand what an ESPP is and whether it might benefit your overall financial plan.
Employee Stock Purchase Plan Basics
In a nutshell, 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 commission fees 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.
Our Team Is Ready to Assist
When making decisions about your finances, it is important to take into account your individual goals and circumstances. Although an ESPP may be a great choice for you, it may not be the best decision based on your specific financial picture. To make sure you are making the right choice for your unique situation, it is wise to speak to a qualified financial advisor.
About Jim Peters
Jim Peters is an independent financial advisor and the founder of Grace Wealth Management Group, Inc., a full-service financial firm committed to helping people pursue their financial goals. With more than 24 years of experience in the industry, Jim combines his extensive knowledge with his genuine interest in helping people pursue financial independence. Beyond his experience, he is certified as both a Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) professional, meaning he has advanced training and knowledge in financial planning and insurance. Based in Irvine, California, Jim specializes in working with individuals, families, and businesses throughout Orange County. To learn more, connect with Jim on LinkedIn or visit www.financialadvisorirvine.com.