By Jason Epps, CFP®, CRPC®
It’s no secret that top-notch employers are always on the hunt for the quality talent out there. And to secure that talent, they know they need to offer some serious perks. From comprehensive healthcare insurance to plush retirement plans, employers are pulling out all the stops to make their workplace an enticing option.
But there’s one feature that stands out from the rest: the Employee Stock Purchase Plan (ESPP). Not only does this feature help attract top talent, but it also aligns the interests of employees with the company’s shareholders. In short, it’s a win-win for everyone involved—but let’s explore why.
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 run the risk of creating a concentrated investment position in their portfolio. As a result, 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 stock 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 the best investment out there?
The capital markets offer a staggering amount of options for which to invest your money. You’ll want to analyze your company’s stock and compare it with other investment options, taking into account the discounted purchase price available in your ESPP. 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
As you consider your financial options, it’s important to remember that what works for one person may not work for another. While an ESPP can be an exciting opportunity, it’s crucial to take a closer look at your unique financial situation and goals before making any decisions. And that’s where we come in. At KFA Private Wealth Group, our qualified professionals can help you navigate the complex world of finance and arrive at a decision tailored to your needs. So why not give me a call at 571-386-2022 or email me directly at email@example.com and see how we can help you today?
Jason Epps is vice president and private wealth advisor at KFA Private Wealth Group, a registered independent advisory firm founded on the premise of providing conflict-free financial and investment advice. With over 17 years of experience, Jason possesses the unique knowledge and expertise necessary to provide his clients with the most applicable and beneficial financial guidance that helps them find confidence in their financial future. Jason is a CERTIFIED FINANCIAL PLANNER™ practitioner and a Chartered Retirement Planning Counselor℠, CRPC®, and believes that a financial plan is only as strong as the advisor’s understanding of the core values and beliefs of each client. He serves a diverse range of clients, from young accumulators to pre-retirees and retirees, including business owners and professionals in a variety of fields. Jason is passionate about giving back to his community and volunteers with various organizations in the D.C. metro area. He also has coached youth travel and AAU basketball since 2009. When he’s not working, you can find Jason spending time with friends and family, traveling, trying new restaurants, and cheering on local D.C. sports teams. To learn more about Jason, connect with him on LinkedIn.