I LOVE my company’s ESPP! Seriously it’s great, because twice a year I get a nice cash payout that I use to boost my index funds.
How ESPPs Work
Most Employee Stock Purchase Plans are exactly the same. You use up to 20% of your salary to purchase company stock at a 15% discount twice a year. The intention behind this plan is to allow employees to become owners of their companies.
Most ESPPs have a major downside: holding periods. There are required holding times for the stock purchased in the plan. Like a 401k vesting period this requires you to hold stock that was purchased in an ESPP for a minimum amount of time before you are allowed to sell.
Never put too much of your net worth in one stock, especially your company’s stock. There are a couple reasons why:
- Holding a single stock is riskier than indexing
- Changes at your job may result in stock price depreciation and job loss
- Holding company stock encourages you to make career moves that you wouldn’t otherwise make
How are ESPPs Taxed?
- Employee Paid for shares are taxes as income tax
- Discount on stock is always taxed as annual income
- Appreciation is taxed as short term capital gains (if held under two years) and long term capital gains (if held over two years)
Here’s an example. If my tax rate is 25% the employee paid section will be taxed as regular income on my W-2 at at 25% rate. The discount is taxed when I sell at that year’s tax rate. The Appreciation is taxed at either 10 or 15% depending on how much in capital gains I capture in that year.
I sell my ESPP stock immediately after I purchase it, so all my shares are taxed at my standard 25% tax rate and have no appreciation.
If the stock goes down in value the drop can offset long or short term capital gains.
Taxes are hard, and this is a simplified view of how ESPP taxes work. If you have any questions contact an accountant or tax professional.
Why I love my ESPP
My ESPP is unique because it has no mandatory holding period, so I simply don’t hold it. Here’s what I do with my ESPP:
- Place 20% of my salary into my ESPP every pay period
- Transfer my personal shares to my brokerage account to avoid commissions and fees
- Sell my shares (with no commission) from the brokerage account
- Purchase index funds over the next 6 months with the extra cash
Things to Know Before Investing
Not all ESPPs are good, and every company is different. In fact most have a mandatory holding period which can be years.
Here are the questions I ask before investing:
- How long is the holding period?
- What fees or commissions do I need to pay?
- How big is the discount?
- Can I get my money back between purchase periods?
- Are there any fees for starting or exiting my plan?
- How volatile is my company’s stock?
I love my ESPP because it gives me an easy payout twice a year. I recommend investing in a stock purchase plan if the fees are low, the discount is high, and the holding period is short. Let me know in the comments if you have questions, or would like a deeper dive into ESPPs, ESOPs, or other employee financial benefits.
