ESPP Help

[mnmiracle]

I have the opportunity to enroll in an Employee Stock Purchase Plan (ESPP) and I can't determine if I should enroll.  The terms are as follows:

- I can buy common shares of the company I work at for a 15% discount to their market value.
- I can contribute via after tax payroll deductions between 1% to 10% of my eligible compensation.
- On each “Purchase Date”, which is the last business day of each calendar quarter (i.e., four times per
year), my accumulated payroll deductions purchase common stock.
- The price paid for the shares will be 85% of the closing price (i.e., a 15% discount) on the Purchase Date.
- A minimum holding period applies to all shares purchased under the Plan. Shares purchased at the end of a calendar quarter (referred to as the “Offering Period”) may not be sold until the next quarterly Offering Period ends. This holding period is approximately
three months.

This plan is a non-qualified plan under Internal Revenue Code 423, so I won't receive beneficial tax treatment.
Additionally, it appears there is a $24.95 transaction fee every time I decide to sell.

My gross annual income is $47,000. 

From the research I've done this is a pretty lousy ESPP, but I don't know if it is so bad that I should not participate.  I've been reading MMM for several months now and know I'll get some good advice here.  Thanks!

[seattlecyclone]

Your ESPP isn't that bad. Getting a 15% discount on stock is like getting an instant 17.6% return on your investment. All that has to happen for you to win (versus investing in VTSAX instead) is for your company stock to not do 17.6% worse than the rest of the market over the three-month period until you can sell the shares. Sure, maybe your company will do that bad sometimes, but it probably won't most of the time. Max this thing out and sell the shares as soon as possible.

[Bicycle_B]

Your ESPP isn't that bad. Getting a 15% discount on stock is like getting an instant 17.6% return on your investment. All that has to happen for you to win (versus investing in VTSAX instead) is for your company stock to not do 17.6% worse than the rest of the market over the three-month period until you can sell the shares. Sure, maybe your company will do that bad sometimes, but it probably won't most of the time. Max this thing out and sell the shares as soon as possible.

+1, absent any further information.

Another tactic would be to hold the shares for a year and a day before selling.  That way, you would get to claim the gains as long term capital gain instead of ordinary income, giving yourself a further savings on the tax rate.

Don't forget to also invest in tax-advantaged accounts, such as an IRA.  At $47k, you're in the 25% tax bracket for ordinary income.  You can put $5,500/year in an IRA as well as use your ESPP; you should do both. 

If your company has a 401k plan as well as the ESPP, you should do that too.  Arguably you should do the 401k before the IRA but after the ESPP.  You can invest enough in the 401k to get down to the 15% tax bracket.  If the 401k has a company match, definitely use 100% of the matching amount.

If you post relevant details, commenters here will probably be glad to sort out any details to maximize your savings.  Move ahead with these things, you will really benefit. 

Here's some background info:
http://www.naspp.com/blog/2015/09/espps-and-401k.html
https://investor.vanguard.com/ira/ira-contribution-limits

[sisto]

It's free money take it!

[mnmiracle]

Thanks for the help folks. I think I'll be maxing that ESPP.

As for tax advantaged accounts, my employer offers a 401k with a 4% match on a 4 year vesting schedule.  I'm currently contributing 10% of my income into the Vanguard Institutional Index Trust (which recently replaced VIIIX in my 401k investment options).  0.02 expense ratio.  I'm also contributing $1,000 per year via payroll deductions into my HSA for health expenses and as a backdoor super tax advantaged investment account.  The 25% bracket at my income is for clowns.

I drive a Chevy Cobalt (35 mpg) and cook virtually all my meals.  I'm getting the basics down while flexing my frugality muscles and dodging face punches.  Thanks again!

[shuffler]

Another tactic would be to hold the shares for a year and a day before selling.  That way, you would get to claim the gains as long term capital gain instead of ordinary income, giving yourself a further savings on the tax rate.

The discount given by the company (15% in this case) is always ordinary income, regardless of how long the stock is held.

In some plans (where the discount is given off of the lower of the price at the beginning of the period versus the end of the period) holding the stock until it becomes a qualifying disposition can *reduce* the amount that is ordinary-income, but will never eliminate it entirely.  The discount given is always ordinary income.

Lots of places to look it up, but this one says it pretty clearly:

http://www.sfchronicle.com/business/networth/article/How-to-avoid-getting-double-taxed-on-employee-6080453.php

However, when you sell shares acquired through an employee stock plan, at least some of your profit is considered compensation and taxed as ordinary income, no matter how long you held the shares.

In my own company's plan, the discount is given only off of the price at the end of the period (which sounds like it's the same as the OP describes).
Thus there is no benefit to holding it for any period of time.  The discount given (10% in my case) will always be ordinary income.
So I sell my ESPP immediately.  I'm already over-weighted towards the company in so many ways (stock options, home value, etc.) that holding any more makes no sense.

[seattlecyclone]

Thanks for the help folks. I think I'll be maxing that ESPP.

As for tax advantaged accounts, my employer offers a 401k with a 4% match on a 4 year vesting schedule.  I'm currently contributing 10% of my income into the Vanguard Institutional Index Trust (which recently replaced VIIIX in my 401k investment options).  0.02 expense ratio.  I'm also contributing $1,000 per year via payroll deductions into my HSA for health expenses and as a backdoor super tax advantaged investment account.  The 25% bracket at my income is for clowns.

I drive a Chevy Cobalt (35 mpg) and cook virtually all my meals.  I'm getting the basics down while flexing my frugality muscles and dodging face punches.  Thanks again!

Sounds like you're on a good path. If you find yourself having more money to save as you build up your frugality muscles, consider increasing your HSA contribution before your 401(k) contribution. Both are great savings vehicles, but the HSA is super duper tax advantaged.

[jamesbond007]

ESPP is generally free money. But I know some companies here in the valley that have restrictions on when to sell (1 yr/2yrs) which makes it a bad deal. But yours is pretty reasonable. I help onto my ESPP for almost 8 years to paid off my student loans, down payment towards my house, etc. I just got lucky as my company stock only grew all the time. If I were to redo the same today, I wouldn't. Instead I would sell them the first day I am eligible to sell. I would be coming out profitable even after I pay short term capital gains. Then send all the money to Vanguard.

[MayDay]

My old employer required a 2 year hold. It was a stable company, so I did put 5% of my income in, but I was cautious because of the hold time.

H's company does not require any hold. We do often hold it for ~3 mo the because the stock price has a seasonal pattern, so we wait for that seasonal upswing.

In our case we do the full 15% that is allowed, which makes us a bit tight on monthly cash flow, so we sometimes spend from the brokerage account. But it's free money so we don't mind.

[turketron]

Your plan sounds decent enough with a minimal holding period, so it'd probably be worth it assuming you're maxed in your other tax-advantaged accounts first. One thing you might want to ask is whether they withhold for taxes when you sell- with my current company's ESSP plan no taxes are withheld at the sale, which bit a few of my coworkers in the behind who sold and then dumped the full amount from the sale into their student loan balances, new car, etc. without holding on to some for paying taxes at the end of the year.

[seattlecyclone]

Your plan sounds decent enough with a minimal holding period, so it'd probably be worth it assuming you're maxed in your other tax-advantaged accounts first.

I think you should do it even if you're not maxing out all your other accounts first. The reason is that participating in the ESPP can lead to a pipeline of free money for as long as you're with the company. You have 10% of your paycheck withheld for three months, you get a discount on stock that essentially turns it into 11.7% of your money overnight. It's then tied up for another three months, at which point you can sell and spend the money on whatever expenses you have. This frees up money from your paycheck to contribute more to your 401(k) going forward than you could do right now, and the benefits just snowball going forward. The longer you wait to start contributing to the ESPP, the longer you leave this free money on the table.

[Bicycle_B]

Another tactic would be to hold the shares for a year and a day before selling.  That way, you would get to claim the gains as long term capital gain instead of ordinary income, giving yourself a further savings on the tax rate.

The discount given by the company (15% in this case) is always ordinary income, regardless of how long the stock is held.

In some plans (where the discount is given off of the lower of the price at the beginning of the period versus the end of the period) holding the stock until it becomes a qualifying disposition can *reduce* the amount that is ordinary-income, but will never eliminate it entirely.  The discount given is always ordinary income.

Lots of places to look it up, but this one says it pretty clearly:

http://www.sfchronicle.com/business/networth/article/How-to-avoid-getting-double-taxed-on-employee-6080453.php

However, when you sell shares acquired through an employee stock plan, at least some of your profit is considered compensation and taxed as ordinary income, no matter how long you held the shares.

In my own company's plan, the discount is given only off of the price at the end of the period (which sounds like it's the same as the OP describes).
Thus there is no benefit to holding it for any period of time.  The discount given (10% in my case) will always be ordinary income.
So I sell my ESPP immediately.  I'm already over-weighted towards the company in so many ways (stock options, home value, etc.) that holding any more makes no sense.

Good catch, Shuffler.  Thanks for clarifying.

Your plan sounds decent enough with a minimal holding period, so it'd probably be worth it assuming you're maxed in your other tax-advantaged accounts first.

I think you should do it even if you're not maxing out all your other accounts first. The reason is that participating in the ESPP can lead to a pipeline of free money for as long as you're with the company. You have 10% of your paycheck withheld for three months, you get a discount on stock that essentially turns it into 11.7% of your money overnight. It's then tied up for another three months, at which point you can sell and spend the money on whatever expenses you have. This frees up money from your paycheck to contribute more to your 401(k) going forward than you could do right now, and the benefits just snowball going forward. The longer you wait to start contributing to the ESPP, the longer you leave this free money on the table.

Ah, good point. 

[triangle]

I would max out 10% of my salary if I could afford the cash flow slowdown. The $25 fee to sell is kind of high but to be expected. If your company pays a dividend or was reliably growing then you may want to accumulate a few quarters worth of ESPP before selling especially if you could not max out contributions thus making the transaction fee to sell a larger percentage.

The 15% discount gives a much higher return than 17.6% if you look at it on an annualized basis.  If you were maximizing your contribution (10% of salary) then consider that you are taking 2.5% of your salary (each quarter's worth) and earning 17.6% interest over only 6 months (one quarter to accumulate and buy, followed by one quarter of waiting before selling). Since the amount is coming out of your paycheck in a steady basis over the quarter some of that gain only has to wait 3 months to further boost the annualized return number.