An Underappreciated Employee Benefit: Employee Stock Purchase Plans (ESPP)
Blog | Budgeting | Planning Perspectives
If you were to ask someone “What are the best benefits an employer could offer?”, most would respond with perks like health insurance, time off, remote work, and if it’s been a long day… a company sponsored happy hour might be a popular choice. They’d also be remiss if they didn’t mention the valuable 401(k) match, which is a benefit that’s often used synonymously with the phrase “free money”, and who doesn’t love “free money.”
However, not too many people are familiar with another sneakily great benefit – Employee Stock Purchase Plans (ESPP). If you aren’t aware of ESPPs, you might be leaving even more “free money” on the table than you’ve realized.
There are a few reasons why you might not be familiar. For one, many companies don’t have an ESPP. ESPP’s are typically only available if you work for a publicly traded company, but even then, not all publicly traded companies have an ESPP.
On the other hand, you might be familiar with your company ESPP and perhaps are even participating in it, but you find yourself with extra company stock without a clear path forward for what to do next.
This blog post is to serve as an introduction to Employee Stock Purchase Plans and some of the things you should consider before participating in your plan.
What are Employee Stock Purchase Plans?
An ESPP allows you to purchase your company’s stock at a discount. For most companies, this discount often ranges between 5% and 15%. To participate, typically your company will have an enrollment period every six months.
Like a 401(k), you get to choose the percentage that your company will withhold from your paycheck over the offering period to purchase your company’s stock. At the end of the offering period, your company will use your withholdings to purchase the stock at a discount.1 You’ll then own shares of your company in a personal brokerage account that you purchased when they were “on sale!”
We’ve been conditioned to love Black Friday and Amazon Prime Day. For some of you, your company’s ESPP is a sale you won’t want to miss.
Key Considerations
Your paychecks will be smaller – Can you afford it?
When you enroll in your ESPP, you’ll be contributing a percentage of your income into the plan during the offering period which will reduce your take-home pay. Can you live comfortably with a smaller paycheck if you participate in the plan?
Remember at the end of the period, you’ll have company stock to sell that you can use to supplement your income, but before then, your immediate take-home pay will be smaller.
Not all ESPP’s are the same…some are lame (relatively speaking)
Not all ESPP’s are created equal. Discount percentages can vary from 5% – 15% and obviously the bigger the discount the better. Now, if you’re a busy tech employee with a million things on your plate, that 5% discount may not seem like it’d be worth your time, which could be fair.
To illustrate, in 2022, the maximum amount you can contribute into an ESPP is $25,000. The table below show’s what the discount would look like on a dollar basis if your plan had a 5% and 15% discount.
Either way, it still is “free money” (if you sell immediately) and yes, there will be taxes, but more on that later. In general, the gold standard ESPP is a plan that offers a 15% discount with a lookback period.1
For some of you, even with the discount, the extra few thousand dollars may not seem compelling with all that you have going on in your life. But remember this, like a lot of other decisions in personal finance, the year-by-year impact may not seem material or impactful, but when you stack years and years of savings, it can move the needle.
Beware, some companies may have lockup periods or blackout windows where you won’t be able to sell the stock immediately. And remember, you are buying an individual stock, which means you are subject to market risk if you don’t have the opportunity to sell or if you hold onto your shares.
Ok, I participated, what next?
Great! You’ve just signed up for your ESPP, what’s next? We often recommend that our clients participate to the max (if they have the budget flexibility) and after receiving their shares from that period, sell the shares immediately or shortly thereafter to ‘lock in’ the gain from the ESPP discount.
As an example, let’s say your company shares were worth $100 when you acquired it through your ESPP, but you were able to purchase it for $85 (15% discount). If you’re able to immediately sell the stock when it’s still trading at $100, you’ve just locked in a $15 gain.
What about taxes?
Taxes are important and need to be considered in any financial decision, but we don’t want taxes to be prohibitive to you taking action, especially if you’ll still be at a net benefit. I’ve specifically put this section at the end because an unfamiliarity with taxes can often scare people from acting, which is totally fair and normal. But paying taxes on “free money”, sounds like a win to me.
Generally, here’s how taxes would work if you were to sell your shares immediately after you receive the stock: You’ll pay taxes on the discount between the fair market value of the company shares and what you purchased the stock for.
Using our previous example, your company stock was worth $100 when you acquired it, but through your ESPP you were able to purchase it for $85 because your plan offered a 15% discount. If you sold the stock immediately for $100, you’ve just made $15 ($100 Current Price – $85 Purchase Price). You’ll owe taxes on the $15 you’ve just gained from selling and this will be taxed as ordinary income. However, like I mentioned earlier paying taxes on “free money” is a win.
If you hold onto your shares for more than a year after acquiring it, you’ll be subject to long-term capital gains tax rates. However, you’ll be subject to market volatility, which could result in a declining stock price.
Here’s a great Turbo Tax article that walks through specific examples of what the tax impacts would be for multiple scenarios: Employee Stock Purchase Plans
Conclusion
In summary, ESPP’s can be an awesome benefit for you! It’ll require some action on your end, but it can be a great resource to help supplement your income and systematize a strategy to help you save more.
Granted, ESPP’s are just one part of your financial puzzle and figuring out how it fits into the bigger picture is important. This is where a good investment advisor can come into play and provide you with the clarity you’re looking for. Reach out if you’d like to discuss of an ESPP is right for you.
Footnote Reference:
1) The discount can be based on the stock price at the end of the offering period or if your company has a lookback feature built into the plan, the discount could be based on either the lower of two prices: the stock price at the beginning of the offering period or the stock price at the end of the offering period.