Connect with us

Advisor

Should You Participate in Your Employer’s ESPP Plan?

Published

Should You Participate in Your Employer’s ESPP Plan?

Have access to an ESPP but have no idea how to work it?

You’re not alone. This is a type of benefit not offered to everyone, so figuring out the best way to leverage it or fit it into your financial plan can be tough.

An employee stock purchase plan, or ESPP, is a benefit offered to some employees as part of a overall compensation package. Essentially, an ESPP allows you to buy your company’s stock at a discount.

That creates a new avenue to explore when it comes to increasing your net worth — but there are some risks involved (as carrying too much of any company’s stock could leave your portfolio without enough diversification).

If you’re not familiar with the ins and outs of your employer’s ESPP plan, let’s take a look at why it could provide you with a lot of value and what you need to consider before taking advantage of yours.

How Does Your ESPP Plan Work (and Why Is It So Valuable)?

Some publicly-traded companies offer employee stock purchase plans as a way to let employees enjoy the success of the company as a whole through discounted shares. That discount usually runs between 5 to 15 percent.

There’s typically an enrollment period, and during this time you can decide how much company stock you want to purchase. Most companies provide a 12-month or an 18-month offering period. That includes a couple of 6-month purchase periods.

When you enroll, your company begins taking contributions from your paycheck until the last day of the current purchase period. At that point, the company uses the funds to buy company stock on your behalf.

In most cases, you can contribute anywhere between 2 percent and 15 percent of your salary, or up to $25,000 per year. Depending on the terms of your plan, there might also be a minimum contribution.

Some companies sweeten the deal of an ESPP plan by doing more than just offering discounted stock. Some plans offer what’s called a lookback provision.

That lets you choose to buy the company’s stock based on its closing price on the first day of the offering period or the last day of each purchase period — whichever is lower.

Say you got a 15 percent discount on company stock through your ESPP plan. At the end of a purchase period, your company’s stock is 5 percent higher than it was at the beginning of the offering period.

If your plan includes a lookback provision, you can choose to purchase the stock at its cheapest price which effectively gives you a 20 percent discount.

Why is this all so (potentially) valuable? Because if you can purchase stock at a steep discount, then you can sell it for more than you purchased, which allows you to earn a profit.

Before you rush to sell your shares, however, there’s still more to understand and consider about your ESPP plan.

Once You Buy In… What Do You Do Next?

If your company offers an ESPP, it may sound like a no-brainer to start buying up as much stock as you can so you can sell it to make money. But while the discount on shares can offer a way to earn some easy gains, you need to be strategic about how you take advantage.

For starters, think about your company stocks in terms of what you can afford. As we mentioned, some ESPPs have a minimum contribution amount.

If meeting that minimum is going to break your budget, it might not be worth putting your short-term financial needs at risk for up to 6 months while you wait for the purchase period to end.

At the very least, you should consult with a financial planner who may be able to create a plan for you so you can take advantage of your ESPP without stressing the rest of your cash flow.

Once you decide to contribute, you need to think through a plan for what you’ll do with the shares you purchase. You have two main options: sell or hold. Either choice comes with advantages and some downsides.

Expect to Pay Taxes If You Leverage Your ESPP Plan

If you sell your shares as you purchase them, make sure to plan for the fact that you have to pay taxes on your gains if you sell your shares immediately. When you sell as soon as you receive your shares, your gain comes from the discount you received on the stock.

In other words, selling immediately means you didn’t earn a gain because the share increased in value, but because you were able to buy it below market value in the first place.

When you sell immediately and receive a gain because you bought at a discount but sold at market value, that gain is considered as part of your compensation and is taxed at your ordinary income tax rate.

But let’s say you decided to hold onto your shares and didn’t sell right away.

If you have any gains beyond the discount — meaning, if your shares increased in value after you bought them — you’d need to hold onto the stock for at least a year after your purchase date and 2 years after the beginning of the offering period to have your earnings taxed as long-term gains.

The advantage of waiting to sell until your earnings qualify as long-term gains is that this will usually reduce the amount of tax you owe on them.

But there’s absolutely no guarantee your company’s stock will increase in value, which means you risk losing money overall.

Related: Your Guide to Employee Stock Options, RSUs, and Incentive Plans

Choose the Right Strategy to Make the Most of Your ESPP Plan

Regardless of the tax ramifications, an ESPP plan is a valuable asset if you have one — and you need to consider utilizing it.

To maximize your earnings, most employees can follow this strategy:

  1. Purchase shares of company stock at a discount (after talking with your financial planner to determine how much of your paycheck to contribute to your ESPP).
  2. Sell as soon as you can and set aside a portion of your gains to cover taxes.
  3. Allocate the remaining funds, after you account for what you’ll need to pay for taxes, to your financial goals.
     

This way, you take on much less risk since you’ll most likely see a gain because you purchased your shares at a discount. If you hold onto them, the share price could go down and you could not only fail to earn anything but you could lose money.

Keep in mind that there are exceptions to this strategy. If you’re confident in your company’s future and expect big returns over the next year or two, it might be wise to hold onto at least a portion of your shares.

But making that call on your own is tough, which is why I can’t emphasize it enough: you need to talk to an objective third-partyto make sure you’re taking the actions with your ESPP that best align with your long-term, comprehensive financial plan.

Continue Reading

Trending