Should I Participate in my Company’s ESPP?

Wealth Advisor

When it comes to your Employee Stock Purchase Plan (ESPP), it’s important to consider your options. ESPPs typically allow you to purchase company stock at a discount, often around 15%. You can contribute up to 15% of your paycheck, capped at $25,000 per year.

Here’s how it works: You make contributions over a six-month period, and on a specified date (usually July 1), the stock is purchased. This purchase can be at a discount or based on the lowest stock price during the period. After purchasing, you have options:

  1. Hold for Over a Year: If you hold the stock for over a year, you’ll pay long-term capital gains taxes when you sell, often at a lower rate.
  2. Sell Immediately: You can sell the stock right away, but it’s considered a short-term capital gain, taxed at your income rate. Consider this if you want to diversify your investments.
  3. Diversify: Many advisors recommend not holding more than 10% of your net worth in one company’s stock. Consider selling and diversifying into other investments.
  4. Section 423 Plan: Some ESPPs are Section 423 plans with specific rules; be aware of any restrictions.

The right choice depends on your financial plan, goals, and the specifics of your ESPP. Consulting a financial advisor can provide tailored guidance.

Video Transcript

So should I invest in my employee stock purchase plan? Is a question we get all the time from clients that work for a larger corporation. Employee stock purchase plan is different from RSUs or Non Qualified Stock options or ISOs.

Background on ESBP essentially it’s a plan that employees can purchase company stock, generally at some sort of discount. On average, companies offer around a 15% discount that could vary. Sometimes it’s the lowest stock price over a given period, or they just get to purchase at a 15 or 20% discount is something that we see.

Generally, 15% of your paycheck can be deferred into an ESPP plan, and these plans are capped at $25,000 per year is the maximum that’s allowed to go in. If you are an owner in a big corporation, you own more than 5% of the company.

Generally, you’re not allowed to participate in these plans. So generally how these work is you make the election over a six month period. So let’s say January 1, you opt into the ESPP plan. You have to contribute from January until July 1.

Say you’re making $250,000 a year, and you’re going to defer the max of 15% of your paycheck into the ESPP plan. If you were going to do the full thing, that would be over the 25,000 per year that’s allowed to go in.

So let’s assume you’re able to max this out at $25,000 per year, and this will be split up over the two six month period. So given this six month period, you’re doing 12,500 into the ESPP plan. So how this works, each paycheck that’s going to be broken up and that’s going to be deferred into a bucket that’s actually going to sit in cash until July 1.

On July 1, there’s going to be $12,500 in this bucket. And that is when the stock is actually going to get purchased on that day. A couple of ways this could be done. Number one, it could be just at a discount.

So they may offer it at a 15% discount of what the stock price is trading. Or number two, could be the lowest stock price over that six month period. So if we’ll use an example, on July 1, the stock is trading at $100 per share dollars period.

But on May 1, it was trading at the low was $15. Low is $50 per share. You’re able to elect to purchase it at $50 per share. But on July 1, you’ll get the value of 100 per share. So an example would be you have 12,000.

July 1, you have $12,500. And you’re going to purchase the stock at the $50 per share stock price. You’re purchasing 250 shares of the stock. So on July 1, when the stock is purchased, it’s at $100 per share.

So you’ve essentially doubled the stock price. So you now have 250 shares worth $25,000. So two things you could do. Now, this would work the same. If you got a 15% discount, you would be purchasing it at $85 per share.

But we’ll stick with the example of you’re purchasing at the lowest stock price over that six month period. You now have $25,000 worth of company stock. You can do one of two things. Number one, you could hold this for a year or continue to hold it.

If you hold it for over year, you pay long term capital gains rates, assuming you’re in the highest tax bracket. If you sold it after a year, you would pay. Capital gains taxes on the growth only because it’s purchased with after tax money.

So you’re not paying any taxes to purchase the stock. Second thing you could do is you could sell immediately and at that point it would be taxed as a short term capital gain. And assuming you’re in the highest tax bracket, you would pay 37% on the gain of $12,500, which would be $4,625 in taxes, and you would net $20,375.

So, planning strategies number one would be if you think the stock is going to appreciate, obviously continue to hold it for a year. One strategy we do with a lot of clients is intentionally defer as much as you can in here.

This would depend on what the discount is. But in this scenario, if you’re able to purchase at that substantial discount and you sell it the day that the stock is purchased, you pay the taxes and you walk away with about $20,000.

You’ve put in twelve and a half and you immediately invest this into a diversified portfolio in a joint investment account. That way you’re taking advantage of any discount that the company offers. Basically can take advantage of the free money that the company is going to give you on the discount.

Other planning tips we never recommend holding more than 10% of your balance sheet in one company stock. So if you have RSUs non qualified stock options, maybe you have ownership in a company and you have an ESPP plan.

Essentially this second strategy might make the most sense to sell immediately and diversify out. Other things to be aware of is a Section 423 plan. This would be a qualified employee stock purchase plan.

They have a lot of the same characteristics, but sometimes can be more restrictive on when you can purchase or when you could sell out of the stock. If you have an ESPP plan, generally there’s many factors that go along with your overall financial plan.

If you should invest. But we’re happy to help, if you have any questions.

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