Is an Employee Stock Purchase Plan Part of Your Benefits? Here’s How to Make the Most of It

A surprising study by the National Association of Stock Plan Professionals found that 65% of companies offering employee stock purchase plans reported that less than half of employees participated in their plans. Even though so many people can access these plans, they fail to use them, often because they simply don’t understand how they work.

An employee stock purchase plan (ESPP) is a company-run program in which workers can buy company shares at a reduced price, usually a 5% to 15% discount. Employees put money into the plan through payroll deductions, and then the company uses these funds to buy stock on their behalf at the purchase date.

It’s a company perk exclusive to employees, meant to align their interests with those of the business and instill a sense of ownership, similar to equity compensation. A solid ESPP can give you a great deal on company stock that can be used to supercharge your ability to achieve key financial goals and priorities. By not taking advantage of your employee stock purchase plan, you could be missing a chance to better secure your financial future.

What could you be leaving on the table by not participating in your employee stock purchase plan?

At the very least, you’re forgoing the opportunity to get a discount upfront, increasing your buying power within the program relative to purchasing company stock on the open market. But it isn’t always a case of simply missing out on that base discount. The biggest missed opportunity is for plans that include lookback provisions.

These plans apply the discount to the fair market value of company stock on the date of purchase or on a specified date in the past (whichever is lower). For example, Salesforce stock was trading at $179 per share on June 15, 2020. Six and 12 months later, on the following two purchase dates, Salesforce stock was trading at $220 and $243. Applying the 15% discount to the lower price in June 2020 resulted in a purchase price of $152, a discount of 45% and 60%, respectively.

Let’s say you see the value and already participate in your company’s ESPP. That doesn’t mean you can set it and forget it. Take these considerations into account to make the most of your investment:

1. Concentration risk

Diversification is a core tenant of investing for a reason. Even if you believe in your company’s growth, investing too heavily in one stock — especially in the company you also rely on for income — can substantially increase the overall risk to your portfolio and potentially result in a major financial setback. Much like a frog in boiling water, avid ESPP investors might not even realize they have become highly concentrated over time.

2. Tax implications of selling

The taxation of ESPP stock is quite complicated, so it’s important to understand how selling stock acquired through an ESPP will impact your tax situation before placing trades. For example, because you aren’t able to withhold for taxes upon the sale of ESPP stock, you might need to make estimated tax payments or increase tax withholding elsewhere to avoid underpayment penalties and a surprise tax bill. Failing to adequately plan for tax considerations can result in costly mistakes.

3. Investing for the appropriate time horizon

Ensure that the company stock you decide to keep is appropriate for the time horizon of the goal you are trying to fund. Most of the time, company stock should be earmarked exclusively for long-term goals, such as retirement, as part of a well-diversified portfolio.

Four tips for those interested in ESPPS

Whether you already use your company ESPP or want to start, these strategies can help:

• Don’t abandon financial planning basics for a good deal. For example, prioritize participation in your 401(k) plan to maximize any matching contributions from your employer. Also, remember that company stock isn’t a good emergency fund. An ESPP can be used to fund short-term goals so long as the stock is sold immediately after purchase and moved to cash. Assess how much of your portfolio is company stock; know that owning company stock differs from owning a concentrated stock position in a business you don’t work for.
• Make sure your current cash needs can accommodate contributions to your ESPP. For instance, contributing 15% of your salary will result in a substantially greater reduction in take-home pay.
• Take the tax consequences of buying and selling stock into consideration and put money aside to pay any taxes. If you want to know the exact financial impact of any investments, it is best to consult a certified public accountant or wealth manager.
• Finally, be aware of the plan rules of your company’s ESPP. Not every plan is the same, so make sure you understand how the discount works along with key dates such as the enrollment date, offering date, purchase dates, blackout periods, etc. Knowing exactly how your company’s stock plan works is key to making it a successful component of your investment strategy.

ESPPs can feel complicated at first, so it’s easy to understand why many employees avoid them. But that could be a mistake. They can be excellent ways to invest in your company — to the extent it makes sense to do so — and provide extra boosts toward achieving your financial goals. The important thing is to ask questions, do your research, and seek guidance to ensure that a good opportunity doesn’t become a drag on your journey to financial independence.

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(Featured image by geralt via Pixabay)

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