Employee stock option plans offer a way to participate in your employer’s success while saving towards short or long term goals. But what exactly is an employee share program? In short, an employee stock option plan allows an employee to buy their company’s stock up to a certain percentage of their salary. The employer then provides a matching contribution up to a certain percent and annual limit. For example, an employee may contribute up to 6% of their annual salary while the employer might offer to match 50% of all contributions up to a certain annual limit.
While it’s a great program, it can result in a reduced retirement income or losing your money if you fail to plan properly. Part of the problem is most employees sign up for the program and that’s the end of it. Once they hear a matching contribution is being offered that’s good enough for them. To avoid such a situation, here are some things to consider and do to maximize your employee share program.
Identify the purpose of the funds
This is an important question to answer. What do you want to accomplish with the money? Is it for short term saving needs or retirement savings? By identifying the purpose of the fund, you can then determine how you should manage your contribution and employer’s matching contribution.
Select the right account that matches with your goal
On a general level, employee share programs offer 3 types of accounts that your funds can be placed in. These accounts are TFSA, RRSP, and a non-registered account. Your contribution along with your employers matching contribution can be set up in one of the three accounts.
Each account has its benefits and tax implications. For example, if the funds are for short term needs such as saving for a vacation, it might be better to place your contributions in a TFSA or non-registered account to enable you to pull the funds without tax implications. Alternatively, if the purpose of the fund is part of your retirement saving plan. You might consider placing your contributions along with your employer’s matching contribution inside an RRSP account.
The takeaway is to spend some time to determine which account is best for you based on the purpose of the account. Lastly, pay attention to each accounts tax implication. RRSP have a withholding tax on withdraws while you might have to pay capital gains on the sale of your shares if it’s in a non-registered account.
Set up an annual review date
It’s great that you’ve decided to enroll in the employee share program to take advantage of your employer’s matching contribution. However, deciding to enroll in the program is just the starting point and not the end of your work. You need to review this account annual for any changes to the program and also to ensure its meeting your saving goals.
Contribute as much as possible
Whatever the maximum contribution limit is, max it out if possible. If you’re allowed to put 3% of your annual salary, do so. Remember the company is matching a percentage of what you contribute, which is the primary reason for doing this program. You want to take advantage of the free money to help you reach your saving goals faster.
If the account is for retirement, avoid planning in isolation
If the purpose of the account is to save towards your retirement, you want to view this account along with your other retirement accounts as one giant account. That means you have to be mindful of your asset allocation, diversification, and fees. The next two points further explain why you have to be careful with using your employee share program as a retirement saving vehicle.
High risk with poor diversification
Using your employee stock plan option as a retirement vehicle carries a lot of risks if done incorrectly. The risk is due to you working for the company, are paid by the company, get benefits from the company, and now you’re betting your retirement on the company’s success. That’s a lot of things you’re depending on your employer for and that puts you in an extremely vulnerable position. As such, you’ve got to secure better diversification to reduce you risk should your employer hit financial difficulty. This means you should have another investment account set up outside your employee share program. Your employee share program shouldn’t be your only retirement account.
Set up an annual date to move funds to your diversified holdings
To follow up on my last point. Since you’re buying a single stock, you have poor diversification as a result. If the funds in your employee shares account are part of your overall retirement fund, then it should be sold and moved every year to a more diversified portfolio holding. Be sure to review any costs and tax implication before moving your funds. You should be able to move the funds once’s the funds have vested.
Do this consistently. Remember having a basket of diversified stock can be risky but betting your retirement saving on a single company is dangerous. Remember Enron and Nortel? I’m sure former employees of those organization learned the hard lesson of betting your future on a single company no matter how great it seems.
There are few times anyone will offer you free money. Employee share program is an effective way to save towards your short and long term goals. The important thing is to spend some time to plan out your goals and objectives to ensure you maximize all the possible benefits while reducing your risk exposure.