Employee Savings Plans: why say no to free money from your employer?

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Josh Miszk
The September long weekend is upon us and, for many, it’s the last chance to spend some quality family time before the transition back to school and work.

The post-Labour Day shift into a more productive mindset offers a good time to review your Employee Savings Plan (ESP), a benefit that can be a great way to save money but can also add some risks.

An ESP is a program set up by an employer that allows employees to contribute a portion of their income into an investment the employer has provided.  In some cases, the employer may also match all or a portion of the contribution made by the employee.

Benefits: free money!

By participating in your ESP you’re basically getting free money.  Whether an employer matches part or all of your contributions, you will be hard pressed to find any other investment out there that provides immediate returns.  Say, for example, that your employer will match 50% of your contributions, up to 6% of your salary (a typical scenario).  All growth and other earnings aside, your investment immediately grows by 50% and your 6% turns to 9%.

While it is a taxable benefit and earnings growth may be taxable, the benefits far outweigh the costs.  Plus, although there may be a short term vesting period, you are typically free to move the money and employer contributions out as you please.  By not participating, you are essentially saying “no” to free money.

Risks

The greatest risk with participating in an ESP is that often the contributions go towards company stock.  While this is a great way for employers to align employee values with the firm, it also poses a risk of concentration to the employee, where essentially, all (or many) eggs are in one basket.  What that means is, the performance risk for your portfolio is somewhat tied to the long-term risk of your employment.

Consider if an unexpected event causes undue financial stress to the company, the stock tanks, and now the company is looking to cut jobs.  So not only are your retirement savings, which are tied to that stock, depleted, but you’re at risk of losing your job as well.

A less extreme, but more realistic, scenario is that the company stagnates and the stock doesn’t grow as fast as other stocks.  Now you’re worse off from an investment angle, but also, your opportunities for career growth are stunted since the company turns out to be a bit of a lemon.

Don’t let the risks scare you away from participating in the program: just be smart about how you mitigate the concentration of that risk.

How to Maximize your ESP

1.) As long as you can afford to do so, contribute the maximum amount at which the company matches a portion of your savings (6% in our prior example.)

2.) If ESP is invested in company stock, reduce the concentration risk by cashing out of the plan periodically (once a year is a good target) and investing in a balanced portfolio.

3.) Make sure the portfolio you’re moving funds to is aligned with your savings goal and is well diversified.

  • a) If you need the money short term, make sure you’re in assets that don’t fluctuate and the savings are in an account that you can access without any significant tax implications, such as a TFSA or a Non-Registered Account.
  • b)  If your goal is long term, like retirement in more than 10 years, you can afford to be in riskier assets and take advantage of registered accounts like RRSPs, which defer tax

4.) Work with an advisor if you have any questions. There are many low-cost options available online where there is no minimum investment required.

Labour Day itself should be one of leisure for you, but not for your money. Take time to review your ESP and make sure you’re getting the most out of it.  You’ll thank yourself down the road.

 Josh Miszk is the Vice President of Investments at Invisor Investment Management Inc., an online financial advisor in Canada that provides personalized investment management services. Josh’s goal is to make it easier for young Canadians, like himself, to create a plan for their families and help them achieve their financial goals sooner.

 

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