If your employer offered you free money, would you say no? Of course not! But if you’re not participating in your company’s Employee Savings Plan that is basically what you’re doing.
An Employee Savings Plan (ESP) is a program set up by an employer which allows employees to contribute a portion of their pre-tax income into an investment that the employer has provided. In some cases, the employer may also match all or a portion of the contribution made by the employee. ESPs can be a great way to save money but can also add some risks.
Here are a few things you should consider when thinking about an ESP:
Benefits of Employee Savings Plans
1. Consistent contributions. By making continuous small contributions on a schedule rather than in a lump sum at the end of the year, your money can work for you longer. You can also take advantage of dollar cost averaging which reduces the impact volatility of your investments
2. A great way to contribute pre-tax money to an RRSP. Since you are not taxed on contributions to your RRSP, by automatically moving cash into a registered account every pay, your employer can move your money into the account instead of including it on your take home pay, which you are taxed on. For example:
At the end of the year, the person who contributed after tax will receive $1,440 back from the Canada Revenue Agency once they complete their tax return, but they would have gone all year having to wait for that money.
3. Employer contributions to your ESP. Employers may match employee contributions to their ESPs, usually matching 50% to 100% for the employee’s contribution up to a certain amount. Think of this as a guaranteed immediate return on your investment of 50% to 100%. There aren’t many investments out there that will do that for you.
4. Deferred Profit Sharing Plans (DPSPs). Employers will share profits of the business by contributing shares or funds to a registered account for the employee. These contributions are tax sheltered until they are withdrawn, and employees may transfer the contributions tax-free to an RRSP.
Note: In some cases, employer contributions to a DPSP need to be vested for a period (i.e. 90 days) before they can be transferred out or withdrawn
In both cases of an ESP or a DPSP, as soon as the vesting period is reached, the employee has control over investment decisions, including transferring the funds into another account.
Risks of Employee Savings Plans
1. Concentration of risk with one company. In the case of a stock purchase plan (and in many cases a DPSP), the contribution goes right into company stock – talk about having all your eggs in one basket! While it can be a great way to save, there may be a significant correlation between the outcome of the company’s stock and your future employment.
2. Your investments may not be suited your specific goals and preferences. Ask yourself these questions:
- Are your contributions going into a single stock or into one of only a few predefined portfolios?
- Have you had any guidance in selecting the portfolio?
- Does your portfolio match your current return and risk expectations?
- Is it suitable for your short- or near-term goal?
Maximize Your ESP
1. Take advantage of an ESP – it’s a great way to start investing early, and is an efficient tool if you use it to contribute to your RRSPs.
2. If you can, contribute at least the minimum amount needed to maximize your employer’s contributions. For example, if your employer matches 50% of your contributions up to 5%, contribute 5% to your ESP, and your employer’s contribution will bump that amount up to 7.5% of your gross income.
3. Diversify your investments. On a periodic basis (i.e. quarterly or annually) review your holdings, look to move what you’ve accumulated in your ESP into an investment which will help you to diversify holdings so that your risk isn’t concentrated in one area.
4. Make sure your investments are suitable to your specific goals. Work with an advisor if you need help defining your risk and return objectives and to select appropriate investments which will get you well on your way to reaching those goals.
At Invisor, we can assist you with transfers from your ESPs and DPSPs. More importantly, we’ll ask you questions that will help you define your goals so we can build a portfolio that is suitable for your needs, and manage it for you on an ongoing basis.
Invisor offers Canadian investors personalized investment management solutions at a fraction of the cost of traditional advisor models, without requiring any minimum investment amounts. Get started now to tell us a little about yourself and your goals, and we’ll find an investment solution just right for you.
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