Aside from offering a sweet salary, employers have a plethora of benefits to offer their employees, ranging from vacation time to 401(k) matching. For many publicly traded companies, one of those benefits is access to an Employee Stock Purchase Plan (ESPP). Investing in your future is critical, but is your ESPP the best place to do it?
What is an ESPP and What Are some Key Considerations?
ESPPs give employees the chance to set aside part of their paycheck to purchase shares of their company stock at a reduced rate, often up to 15% off fair market value. And while that may sound like a solid investment benefit, there are several considerations you need to consider before deciding whether to invest in your company’s ESPP.
Financial situation
Before investing, make sure your personal finances are taken care of. Stocks can be volatile, and selling them can have tax consequences. Many financial advisors suggest having at least 3-6 months of expenses saved in an emergency fund, having your debt paid off, and meeting your employer’s match for your 401(k) before considering an investment in other areas.
Qualified or non-qualified?
While the stock purchases themselves are always paid for with after-tax money (meaning they are not tax deductible), there are other tax considerations you may need to consider. If your company offers a qualified ESPP, you will not be taxed at the time of purchase on the fair market discount offered by your company.
However, if your company’s ESPP is non-qualified, you will have to pay taxes on the discount at the time of purchase. Your discount will be taxed as ordinary income at the time of purchase. That doesn’t mean you shouldn’t invest through the plan, but it does mean that your purchase discount may not ultimately be as large as it seems to be.
Timing considerations
The taxes on qualified plans aren’t straightforward, either, as sales for qualified ESPPs can be classified as qualifying or non-qualifying dispositions, which adds tax complications.
Before investing in your company’s ESPP, make sure you understand the length of time you need to hang onto your stocks for the most beneficial tax treatment. You should also know that your company may have blackout periods where you can not sell the stock. This makes it even more important to consider your entire financial position before you begin investing through the ESPP, as your money may not be accessible during these times.
Investing best practices
Diversification is important when you’re considering whether to buy company stock, especially if you’re saving for retirement and investing long term. You may already be invested in your company through your 401(k). If a large chunk of your assets is already tied up in your company stock, it may be wise to diversify instead of continuing to put all your eggs in one basket.
Your company’s prospects
A 15% discount on shares of a company whose value is going down might not be a wise investment. Even though you work there, keep an eye on how the stock is doing and then make your ESPP investments accordingly.
Your company’s ESPP can help you buy stocks at a discount, which can benefit your bottom line. But you’ll need to keep your money invested for at least a year and be aware of any tax consequences when you’re ready to sell.
