When Buying Employer Stock Is Smart—And When It’s a Huge Risk

Buying your employer stock at a discount through an employee stock purchase plan (ESPP) can be an appealing benefit, and in many cases, a financially rewarding one.

However, before you sign up or determine how much to contribute, it’s important to examine the details closely. ESPPs come with specific rules, potential tax consequences, and investment risk. Understanding how the plan works and how it fits into your broader financial goals will help you decide if participating is the right move for you.

Here’s what to consider before buying into your employer stock purchase plan.

Understand How ESSPs Work and How Much You Can Contribute

Most ESPPs let employees purchase company stock at a discount of up to 15% off the market price. During the offering period, contributions are typically made via payroll deductions and the money is used to buy shares on the purchase date.

“You can opt in to participating in the program whereby a set amount is withheld from each paycheck and periodically (usually every six months) the total is used to buy your employer’s stock at a discount,” said Danika Wadell, certified financial planner, registered life planner, and founder of Xena Financial Planning.

You’re typically allowed to contribute up to 15% of your salary, and the amount of stock you can purchase annually limited to $25,000. This leaves a lot of room to invest if your budget allows, but if you already own stock, consider whether the purchase makes sense for your long-term financial goals and how it impacts your portfolio and asset allocation.

“Considering how much you can afford to set aside is essential. You must also consider how much of your company stock you already own and whether it is wise to invest more in the company,” Waddell said. “Individuals may also be limited by how much ‘extra’ cash they can afford to set aside every paycheck. Factoring in any additional stock grants from the company is also part of the puzzle.”

Confirm Holding Requirements and Tax Implications

Once your stock purchase is complete, you can decide to sell it or hold onto it. But the rules and tax implications around this vary. Some ESPPs allow you to sell the shares immediately after purchase, while plans that qualify under IRS Section 423 have special tax rules that provide you with certain tax benefits for holding shares for at least one year after the purchase date and at least two years after the offering date.

If you sell after meeting both the one-year and two-year holding periods, it’s a qualified disposition. This means you’ll pay ordinary income tax on the discount, and any additional gains are taxed at long-term capital gains rates. However, selling earlier is a disqualifying disposition, resulting in more income tax at higher ordinary income rates.

“ESPPs can be great, but they also introduce tax complexity and can be a lot of work to manage (specifically around the selling and reinvesting of proceeds). There are times when I advise a client not to participate, as the added complexity isn’t worth the additional hassle,” Waddell stated.

Weigh the Investment Risk

Even with a discount, buying individual stocks, especially in the company you work for, adds risk to your financial portfolio.

You already rely on your company for your salary and possibly your retirement plan. Investing more in the same company could overly concentrate your financial future in one company. Additionally, if the business is struggling or highly volatile, the discount may not be enough to justify the risk.

“If you are already receiving other types of equity compensation (such as restricted stock units), you can end up with a very significant amount of your company stock. You have to be disciplined about how and when to sell to avoid the potential volatility of holding a single concentrated position,” explained Waddell. 

If company stock makes up a large portion of your investments, it may be better to limit your purchases or sell shares periodically to maintain a balanced portfolio.

Work With a Financial or Tax Professional

Participating in an ESPP comes with complexities, especially when it comes to taxes, timing, and managing investment risk. If you choose to participate, be prepared to work with a financial advisor or tax professional.

“If you don’t already use a tax preparer/accountant, you will almost certainly need one if you are participating in an ESPP,” Waddell recommended.

They can help you make informed decisions about how much to contribute, when to sell your shares, and how to minimize taxes.

The Bottom Line

Purchasing your employer stock at a discount can be a valuable financial opportunity, but it’s not a one-size-fits-all decision. While it comes with great benefits, tax treatment and risk make it a little more complicated than investing in your 401(k) or individual retirement account.

Take the time to understand the rules, consider how an ESPP fits into your broader goals, and don’t hesitate to seek professional guidance when you’re considering buying in. With the right strategy, an ESPP can be a smart way to build wealth while staying invested in your company’s success.