A Guide to Your Employee Stock Purchase PlanSubmitted by Castlebar Asset Management on October 20th, 2016
Employee stock purchase plans (ESPP) give plan participates the ability to purchase shares in their company stock at discounted rates. ESPPs are sometimes overlooked, but they are a smart way to invest and you could be leaving thousands of dollars in free money on the table by not taking advantage of your company’s plan.
What you need to know
About one in five public companies offer ESPP according to Aon Hewitt. If your company does offer it there is a pretty good chance you are not participating since less than a third (31%) contribute to their plan. Your ESPP will allow you to buy company shares at a discount. Employers will deduct your contribution amount from your paycheck and place it into an account where it will accumulate for a period of three to six months. At the end of the three or six month period (the purchase date) shares will be bought for you at a discount. The discount ranges from 5% to 15% but check your plan documents for specifics.
The purchase price is the price of your stock at the market close (minus your discount) on the purchase date unless your company has a lookback provision. Lookback provisions allow you to purchase shares at the lower price (minus the discount) of either the price at the start of your offering period or on the purchase date. This gives you the best opportunity for profits! If the stock is at $100 at the start of your period and ends at $110, you will buy your shares at $85 or $100 minus the 15% discount.
The maximum contribution you can make to an ESPP is $25,000. This amount is an IRS rule not something specific to your company plan. Some plans also limit your contribution to 10% of your take home pay.
Things to keep in mind
Participating in an ESPP is an overlooked way to accumulate net worth. Getting a boost from the discount and possible appreciation in your company’s stock price. One common issue we see is employees don’t sell shares in their ESPP. As high as 59% of employees never sell while they are at their employer. This can lead to holding a concentrated position in your company stock and the urgent need to diversify. People tend to hold on to their shares out of loyalty, being part of the team or just don’t know what to do. Work with your financial planner or tax professional if you need help or have questions.
When to sell?
The brokerage firm who holds your shares and administrates the plan (usually Schwab or Fidelity) will let you know if there is a holding period for your shares. The majority of plans don’t have one which means you can sell your shares for a profit quickly if you want. Taxes do play an important part in any decision to sell.
We will focus on Qualified ESPPs since the vast majority fall under this type. The tax treatment when you sell is based on how long you have held your shares and your tax bracket. The discount you receive on your shares is taxed at your ordinary income tax rate, let’s assume 33%. If you sell your shares immediately your profits would be taxed only at your ordinary income rate. If you hold onto your shares for longer than a year after you purchase them you get more favorable tax treatment. You will still pay ordinary income tax on the discount received but your other profits will be taxed at long term capital gains rate. Remember you only pay tax when you sell.
ESPP are another tool for you to grow your net worth. They do require a little more attention than your 401k because you are the one who is going to make the decision to sell. As your balance increases it will become more important to understand how your ESPP fits into your overall financial plan. If you don’t take action it could lead to having a concentrated position in your employer’s stock and you may be taking more risk than you should be.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your personal financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.