Employees often have the opportunity to take part in a benefit called the Employee Stock Purchase Plan (ESPP). This allows employees to buy up to $25,000 a year in company stock at a discount, sometimes up to 15%.
This benefit encourages employees to become more engaged in the success of the company by owning stock. While this can be good for the company and the employee, there are important considerations in deciding whether to participate.
Cash Flow Impacts
- Since shares are purchased through payroll deductions, you are losing your earned income that may be needed for expenses. Hence, the first question to ask yourself is if you can afford a reduction in your net take-home income.
Savings Alternatives
- If you are not already maximizing your company retirement plan contributions (i.e., to your 401(k)), you could be foregoing a more attractive savings opportunity including material tax benefits and/or company matching that could exceed the ESPP purchase discount rate.
Higher Investment Risk
- All stocks have inherent investment risk, but a concentrated holding in one stock includes higher risks as you are dependent upon one company’s performance. As such, you must be confident in the company’s long-term business outlook. A company in a competitive market or with a history of a volatile stock price might face higher risk in its stock’s performance.
The risk of a concentrated holding could be higher if you receive Restricted Stock Units (RSUs), stock options, performance shares, or other stock employee benefits.
Inability to Sell
- Another risk factor could apply if you are subject to “blackout” windows. This occurs when a company restricts employee stock sales during certain periods, thereby limiting your ability to sell the stock for investment reasons or for liquidity needs.
Foregone Investment Opportunities
- An important consideration is how the stock fits into your overall portfolio. If buying ESPP shares detracts from your ability to invest in a more diversified portfolio, you could be risking your ability to achieve your long-term financial goals.
Tax Treatment
- You must be aware of the tax treatment of owning and selling ESPP shares. Lower tax rates apply when you realize a long-term capital gain, requiring you to own the investment for more than one year. The tax laws are different for ESPP shares, and sales can result in adverse tax impacts if sold too early.
Before participating in an ESPP, it’s crucial to carefully consider your financial goals, risk tolerance, tax impacts, and the specific terms of the plan. SageVest Wealth Management can help you evaluate the potential benefits and drawbacks of an ESPP and determine if it’s a suitable investment for your situation. Please contact us for more information.
