Would you consider purchasing discounted shares of your employer’s stock?
A opportunity may be available to you if you work for a publicly traded company through an employee stock purchase plan, or ESPP.
In 2018, an ESPP was provided by nearly seventy-five percent of publicly traded corporations, according to a Deloitte poll. These are frequently used by employees to increase retirement savings: According to a 2020 Fidelity research, employees who engage in both a 401(k) and an ESPP make 32 percent greater contributions to their 401(k) than those who invest in simply a 401(k).
However, according to experts, there are many factors to take into account before participating.
“Any time you’re investing in single company, there’s certainly a big risk,” said Kristin McKenna, managing director of Darrow Wealth Management in Boston and a certified financial adviser.
The employee stock purchase plan working mechanism
ESPPs are frequently made available to all employees and may let you buy company stock at a discount of up to 15%, with a limit of $25,000 per year for tax-qualified plans.
During a “offering period,” the plan collects contributions after taxes from each paycheck, and on a predetermined date, utilises the money to purchase business stock.
“The gold standard for a plan is going to be a 15% discount with a lookback feature,” stated Bruce Brumberg, co-founder and editor-in-chief of myStockOptions.com.
The stock purchase price is calculated according to a “lookback” clause using the lower of the value at the start or conclusion of the offering period. Let’s imagine, for illustration’s sake, that your ESPP provides a lookback and a 15% discount. You will secure a 15 percent discount on $20 with a starting price of $20 and an ending price of $22, saving you a total of 22.7 percent per share.
In a research conducted by Morgan Stanley at Work from 2022, it is said that about 4 out of 10 publicly traded corporations provide discounts and lookbacks for ESPPs.
Things you should consider before selling your shares
Although selling your discounted shares may be alluring, there are complex tax regulations to take into account, including charges on the reduction. Depending on when you sell, the distribution of monthly income and better long-term capital gains will change.
You might also need to maintain the shares for a specific amount of time under your employer’s requirements. “Some companies have an additional holding period requirement,” Brumberg said. “They don’t want you to flip the shares.”
In the strategy paper, there are undoubtedly further important aspects to verify.
According to him, you’ll need to know how to enrol in the ESPP, the length of the offering period, purchase dates, how to make adjustments, and what happens if you withdraw from the plan. You’ll also want to know whether the ESPP is tax-qualified, which might give savings.
Look out for all the options available before an ESPP
Although a declining market can provide an even greater discount, allowing you to purchase more shares, there are other trade-offs to take into account before investing heavily.
Because “stocks don’t always go up,” McKenna said, there is no assurance that you will turn a profit.
According to a J.P. Morgan analysis, the majority of individual stocks do not outperform the market. The study reveals that between 1980 and 2020, roughly 46% of Russell 3000 Index companies saw a price loss of 70% from their peak and never recovered.
Given these dangers, experts might advise using an ESPP in addition to your 401(k) rather than as your main method of saving and investing. And before enrolling, you should consider your risk tolerance and goals.
According to McKenna, an ESPP can be a good idea if you’re already accomplishing your other financial objectives, such as funding your 401(k) to the maximum, opening a brokerage account, paying off debt, or other savings targets.
She replied that while it might work once you’ve “checked all the other boxes,” it could be preferable to concentrate on other planning opportunities first.
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