Employee Share Purchase Plans – What You Need To Know

When it comes to compensation, people working full time usually just think about their base salary and/or commission as their compensation. For those who work at publicly traded companies, there is probably an employee share purchase plan that you can join. Participating in an Employee Share Purchase Plan (ESPP) is an excellent idea as they lead to building wealth over the long term!

Since there are so many configurations of ESPP, I’ll use my previous employer’s plan as an example. Here were the features of the plan:

• 1-10% of your pay could be deducted for the ESPP each pay period (employee specifies how much to deduct)
• My employer would match my contribution up to 3%
• To receive the employer contributions, you must be a member of the plan for 2 years
• There are no fees for purchasing shares
• Cash distributions from dividends were invested back in the form of more shares (like a DRIP)
• Shares can be held in a normal or tax deferred account (RRSP)

Related: 4 Reasons To Add Dividend Stocks To Your Portfolio

Joining the plan

Let’s say you earn $60,000 per year (gross) and you want to participate in your employer’s ESPP. You want to save some money but think 10%, the maximum contribution, is out of reach so you opt to contribute 5% of your pay.

Your after tax, biweekly pay is $1,703.75 of which another $85 is deducted and put into your share purchase account. Your employer matches your contribution (3%) so you will receive another $51 for a total of $136.

Over 26 pay periods (one year), you will contribute $2,210 and your employer will contribute $1,326 for a total of $3,536. The employer contributions are basically free money!

Performance over a one year period

So what about the share price? Since you are buying shares every 2 weeks you’ll be buying them at different prices throughout the year. Buying shares on a regular basis insulates you from both big gains and big losses. ESPPs are meant to build wealth over the long term so don’t worry too much about fluctuations in your company’s share price in the short term.

I’ve prepared an example which has been simplified down to a monthly schedule, instead of biweekly. I have rounded off some of the calculations for the sake of this exercise. This purchase schedule assumes:

• Monthly contributions of $294 (136×26/2, combined employee plus employer)
• 3% dividend yield paid quarterly
• Dividends are re-invested
• Company shares trade at $10 at the start of the year, fluctuate throughout the year and are worth $11 at the end of the period

Related: 2012 Portfolio Performance – Did we beat the market?

So how did we do after a year in the ESPP?

Total Shares Bought        344
Your Cost                            $3,536.00
Value After 12 Months  $3,808.03
Gain/Loss                            +7.7%

In this scenario your investment would have returned almost 8% with dividends reinvested, that’s pretty good! But wait, what about the employer contributions?

If you subtract the employer contributions of $1,326, your cost is actually $2,210 instead of $3,536. This means your 12 month return is actually 42%!!

Would you ever have thought that contributing to an employee share purchase plan could be such a great investment? Where else are you going to be able to generate a 42% return in one year?!

Keep in mind that in this scenario you are only contributing 5% of your pay but the maximum is 10%. We could see even better returns if we contributed more however our employer is already contributing the maximum of 3%.

There is always the possibility that your shares will decrease in value. Given that shares are purchased on a biweekly basis, your risk will be spread out over a long period of time. You can also suspend or cancel contributions if your company’s stock price suddenly takes a nose dive. There is still an element of risk in these plans.

Related: What is an RRSP?

Don’t forget the tax man

We do have to keep one thing in mind, taxes. The government will take their cut from your profits in several ways, you will pay taxes on:

• The employer contributions (this is a taxable benefit)
• The dividend payments
• Your capital gain when you sell your shares

Thankfully, the administrator of the ESPP will keep track of the first two items and will issue you the paperwork for your taxes.  If you hold the shares in a tax deferred RRSP, you’ll only pay tax on the employer contributions.

Why ESPPs are so great

As you can see, these plans are great for a number of reasons.

• You are forced to save a small percentage of your paycheque (1-10%)
• Your employer contributes (basically free money)
• Your returns are essentially leveraged since you are investing your employer’s money
• You are exposed to the stock market in a low risk way (shares are bought biweekly)
• Dividends are reinvested
• There are no fees

If your employer offers a share purchase plan, look into the details and start participating!