Company stock loses its luster in 401(k) landscape
Employee stock purchase plans are becoming more popular among larger public companies at the same time employees have reduced the amount of company stock they purchase within their 401(k) plans.
A recent analysis by Fidelity Investments shows that the percentage of employees participating in their employee stock purchase plan increased to 28% in 2016, up from 23% in 2014. One of the big reasons for this increase is that ESPP money is held outside of a 401(k) so the shares are more accessible. That means that those shares can be accessed easily in times of financial emergency.
Meghan Murphy, director, thought leadership at Fidelity Investments, says that there are fewer employers offering company stock as an investment option in retirement plans and that in the past decade, many employers have worked to ease the administration of their plans as well, which helped reduce the number of companies offering company stock.
After the Great Recession in 2008, people grew more conservative, she adds, and there was more education on the part of employers about holding balanced portfolios.
“Prior to the advent of target-date funds, we saw a lot of people who either had 0% equity or 100% equity,” Murphy says. “They weren’t quite sure how to balance that.”
Now, “we don’t tend to see people have that much of their portfolio in stock. How much stock they own is based on their risk tolerance, years until retirement, the other options in the plan and really what they are comfortable with,” she adds.
Plan education has improved and employers have made it easier for employees to make their investment selections by offering fewer investment options in their plan. On average, companies offer 30 investment options compared to the hundreds they might have offered in the past.
The issue with company stock is that it is volatile, says Kara Tedesco, principal at global consultancy and actuarial firm Milliman. It can be a risky investment in the 401(k) plan depending on how the stock market is doing and how the company itself is performing.
Companies are shying away from offering company stock within their 401(k) plans because they believe there is a risk associated with having plan participants put too much of their account balance into one single investment. Many companies offer company stock as matching contributions on a plan participant’s plan contributions, but if the employee doesn’t do a good job of managing how much stock they have in their portfolio, it can grow really quickly, Tedesco says.
“Employers want employees to be invested in the company and reap the same rewards and have the same rewards and benefits the employer is getting but overall it can hurt them if the market goes down or the company encounters financial distress,” she says.
It is up to plan sponsors to put limits on how much company stock an employee can hold in their retirement account, say a maximum of 25% of their retirement account balance. Plan sponsors also have to do a better job of educating employees about what it means to hold company stock and the volatility and risk associated with that type of investment.
If a company doesn’t tell plan participants that stocks can be a risky investment, they can come back and sue the plan because they didn’t know what the risk or return would be on that type of investment.
“Making company stock available to employees is a great way for companies to motivate their workforce and give workers a sense of ownership in their company, as well as help attract and retain talented individuals,” says Mark Haggerty, head of Stock Plan Services for Fidelity Investments.
“However, employees should remember that their company’s stock, just like any other stock, should be part of a balanced and diversified investment portfolio, especially if it’s part of their 401(k),” adds, Haggerty.
So long, employee equity stake
Fidelity found that the percentage of employees with company stock in their 401(k) has dropped by almost half from 41% in 2005 to 23% in 2016. More than one in four employers still offered company stock through their 401(k) plans in 2016, a drop from 39% in 2005. Fidelity also found that 9% of employee 401(k) assets were in company stock in 2016, down from 16% in 2005.
The company also found that “employees are generally optimistic about the future performance of their company stock,” with 83% of employees who participate in their company stock plan expecting the value of their company’s stock to increase over the next few years. More than half expect the value of their company’s stock to increase at a modest rate and 21% expect the value to increase substantially in the next two years.
Emily Cervino, vice president at Fidelity Investments, says that employee stock purchase plans are very similar to 401(k) plans in that they are available to all employees, they are voluntary from an employee perspective and are funded through payroll contributions. That’s where the similarities end.
Most ESPPs allow employees to purchase company stock at a discount. The typical discount is 15%, “though there are some design features that can stretch that discount,” she says.
Many ESPPs offer a look back option. After employees contribute money to the plan for between three and six months, the money aggregated in the account is used to purchase company stock at a discount. The look back option allows the employer to offer employees the cheapest rate available during that contribution time frame. So, even if the company’s stock has increased in price during the period in which employees were contributing to their ESPP, the employer will still offer the lowest price per share available during that time.
“What’s happening in the ESPP landscape is we’re seeing overall companies are becoming more aggressive with their plan design features. There are a variety of discounts and features employers can include in their plans,” Cervino says. “Part of that is coming from companies’ desire to have a competitive benefits package in a tight labor market and it can be a distinction to have an attractive ESPP.”
Participation in ESPPs continues to improve year over year. “Companies are doing a better job helping employees to understand these plans and how it fits into their own personal financial picture,” she says.
One big benefit of ESPPs is that many companies don’t require employees to hold their company stock for a set length of time before they sell it. That means that employees can turn around and sell it immediately for a gain since they purchased the stock at a discount.
That said, Fidelity finds that 50% of people continue to hold all or a portion of their company shares three years after they purchased it.