Are ESPPs good investments?
Are you wondering if ESPPs are good investments? These plans can be great investments if used correctly. Purchasing stock at a discount is certainly a valuable tool for accumulating wealth, but comes with investment risks you should consider. An ESPP plan with a 15% discount effectively yields an immediate 17.6% return on investment. To understand this return, consider a stock trading at $10 per share. An employee with access to an ESPP program with a 15% discount is able to purchase shares at $8.50. He or she can immediately sell shares for $10. This sale results in an immediate guaranteed profit of $1.50 per share on an investment of $8.50 per share of 17.6%. Using the maximum $25,000/year contribution to an ESPP plan, this translates to a $4,411 “gift” from one’s employer each year. Over a 30-year career, this employee benefit is worth $132,330!
Should I participate in an ESPP and if so, how much should I contribute?
You may be wondering if you should participate in an ESPP and how much you should contribute. It’s best to consider an ESPP contribution strategy in the context of one’s overall financial plan. Personal financial strategy often involves weighing a variety of interrelated investment, tax, budgetary, and behavioral considerations, which can be overwhelming to individuals who don’t have professional help and the right tools. Although everyone is different, we do see some common patterns.Highly compensated employees at firms offering ESPP programs are often also awarded stock options and restricted stock as part of their compensation. If their company has done well, they may actually own too much of their company stock (as a percentage of their portfolio). Additional purchases of employer stock would further concentrate their investments and create unnecessary risks, if the stock fails to perform. They may still want to take advantage of their 15% ESPP discount and have the income to save. In addition, these people often have access to several types of tax-advantaged accounts. These include traditional or Roth retirement savings, Healthcare Savings Accounts, or Deferred Compensation plans that offer better long-term tax advantages than their ESPP program. One strategy we like for these highly compensated clients involves a cycle of maximum ESPP contributions, simultaneous sales, high-basis shares, and immediate investment of proceeds in tax-advantaged accounts.
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