Owning a chunk of stock in the company you work for isn't just for the guys with makeshift putting greens in their corner offices. Plenty of publicly traded U.S. companies, including about half the firms in the S&P 500, per professional services firm Aon, offer an employee stock purchase plan (ESPP), which allows the rank and file to periodically purchase shares in the company at a discount.
Before you enroll in such a program, you'll need to strategize, considering not only the risks of holding a large chunk of stock in the firm you work for but also how such an investment will mix with other, more common retirement savings vehicles, such as a 401(k).
The good news for potential investors: Employees with access to a 401(k) and and ESPP are frequently using the opportunity to boost their overall savings rate by investing in both. A recent survey from Fidelity found that about 90% of ESPP investors also saved through their 401(k). Employees who contribute to both types of plan tend to sock more money away overall, researchers found, with dual savers stashing 12.5% of their salaries in 401(k) accounts and 6.3% in ESPPs, compared with an 8.8% savings rate among people who invest in a 401(k) alone.
But maximizing your savings is far from the only thing to consider when investing in these plans. Read on for the important considerations you should factor in to your ESPP strategy.
Enrolling in your firm's ESPP allows you to buy company shares at a discount of up to 15%, though markdowns vary from company to company. Once you opt in, you'll choose a percentage of your after-tax income for your company to withhold from your paycheck for a timeframe known as the "offering period," which usually lasts six months. When that period ends, the company buys stock for you and everyone enrolled in the plan. Your discount will often be assessed on the lower of two prices: the share price at the beginning and at the end of the offering period.
The account in which you hold your company stock is taxable, though you won't be taxed until you sell your shares. Once you do, you'll pay regular income tax on the amount of your discount and, depending on how long you hold your shares and how much they appreciate, some form of capital gains tax on your portfolio gains.
The income tax you pay on the amount of your discount means the percentage your firm advertises is "a little misleading," says David Mendels, a New York-based CFP and director of planning at Creative Financial Concepts. "Still, since tax rates are well under 100%, it's still a discount."
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To decide if investing in your ESPP is right for you, look past the obvious allure of the discount, says George Gagliardi, a certified financial planner and founder of Coromandel Wealth Management in Lexington, Massachusetts. "It is an investment, and just because one can pay 15% less for it than the prevailing market price doesn't necessarily make it a good investment," he says, noting that a 30% loss on a stock previously purchased at a 15% markdown would still result in an 18% overall loss for the investor.
Another consideration for ESPP investors: a lack of diversification. Having a big swath for stock in one particular company means that movements in that company's stock price can have an outsize effect on your portfolio.
Making a big bet on your own company that pays off comes with a certain satisfaction, but a losing bet can be doubly painful, says Charles Rotblut, vice president of the American Association of Individual Investors. "If your company doesn't perform well, you could find yourself in a situation where your retirement savings are going down when you're also potentially at risk of losing your job or having your salary cut," he says.
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Rotblut doesn't disapprove of investing in ESPPs altogether. "If there's an attractive discount, it's worth considering," he says. "But it shouldn't be your primary savings vehicle."
Instead, invest the bulk of the money you set aside from your paycheck in your 401(k), he says. Investors should use the plan's roster of mutual funds to build a broadly diversified portfolio and invest at least enough to get a matching contribution to the plan from their employer.
Once you've established a diversified core portfolio, use the ESPP to branch out, Rotblut says. "I'd look at the ESPP as supplemental savings," he says. Regularly assess your company's stock the same as you would any other publicly traded firm's, by checking in on the company's earnings announcements and conference calls for signs of financial health, such as steadily growing earnings and cash flow, he says.
If that all sounds like a lot to do, keep things simple and start saving in an account you fully understand, he adds. "If you're young, start saving early and think about having most of your money in stocks," he says. "Start saving first, and worry about what kind of account it's in second."
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