ESPP max contribution

[nawhite]

I have a first world problem.

I am choosing how much to contribute to an ESPP through work. The plan is a standard 15% discount off the price today or price 6 months ago, whichever was less. I can sell the day after the shares are purchased and plan do do so for a number of reasons. I can contribute up to 20% of my income ($115k). The stock hasn't been very volatile but has trended downward over the past year.

My problem is the IRS rules for the maximum you can get from an ESPP. My understanding is that the market value of the shares purchased can not exceed $25,000 for the year (please correct me if I interpreted that wrong)

So in my situation, if I put 20% aside, I end up with $23k/ year of contributions available to purchase shares. If the share price went down (worst case) I would only get the 15% discount. This 23k would buy $27,058 worth of shares. Unfortunately that is more than the IRS limit of $25k. So in this case the first $21250 of my contributions would be used to purchase $25k and I'd have $1750 leftover in the account not earning interest and not doing anything until the next purchase window in 6 months. (This means the most I would contribute is $18.4%)

If the price goes up, then this gets worse as less of my contributions would be required to buy $25k in shares and then more would sit in the account doing nothing until the next purchase window.

Anyone have any recommendations about what amount to contribute? If I contribute too much and the stock goes up, I leave money in the account. If I contribute too little, and the stock goes down, I miss out on some of the 15% discount (17.6% return). I index invest so I don't have to think about these things!!!

Anyone ever dealt with the ESPP cap?

[TWP21]

You're right, this is definitely a first world problem!

Most plans allow employees to increase or decrease their payroll deduction percentage at any time during the offering period (check your plan documents to make sure this is the case).  Assuming your interpretation of the IRS rules is correct (check with a professional), here is one way to handle it:

1) Start out by withholding the max of 18.4%
2) Keep an eye on the stock price throughout the purchase window. If it drops, stay at 18.4%. If it goes up, adjust contribution percentage down accordingly to reach your target overall percentage, even dropping the final few contributions to 0% if necessary.

Obviously this method is not perfect, but ESPP is usually such a good deal that I'd err on the side of having slightly too much in your account rather than too little. I would be interested in hearing other opinions.

[Khan]

Talk to HR and find out if it automatically caps out? If your company is badass enough to provide ESPP up to 20%(mine's only 5% :(), they should have the system set up to refund you at the end of the purchase period... right? I mean my 401k automatically stops contributions at the limit.

[nawhite]

According to their documentation, they will only automatically purchase up to the limit and the remaining funds will stay in your account. Whether this is true or not is a different question.

@TWP21 - Good idea about changing the contribution. I'll have to look at whether or not that is possible. I think I may have to set a withdrawl percentage and keep it the same throughout or bail out completely for that window. I have to double check.

[msilenus]

I blow through the cap every year.  The stock purchases stop at the limit, and I get paid in January for the unspent money in the ESPP account.

YMMV.

[travis_cooper]

I realize this is kind of an old thread, but it came up as I was researching some information about ESPP programs.  So, I thought I'd throw this in for anybody else that stumbles upon this thread.  The way the contribution limits works is all based on the closing price of the offering date.  So, if the stock closes at $20 on the first day of the offering period, and just to simplify things, let's say it is a one year period (instead of the two 6-month periods the OP has).  You will be allowed to purchase $25K/$20 = 1250 shares for the year.

If the stock ends up going down by the end of the year, to let's say $18.50, and you get a 15% discount, that means you'll buy 1250 shares at $15.725 each totaling $19,656.25.

If the stock instead goes up for the year, to $23, and you get a 15% discount (in most cases this would be a discount on the opening price for the year), that means you'll buy 1250 shares at $17.00 each totaling $21,250.

So in the first scenario you are only able to put in $19,656.25 and the current value of your 1250 shares is $23,125.  In the second you are able to put in $21,250 and the current value of your 1250 shares is $28,750.  In the first case your gain is around 17.6%.  This is always your gain if the stock goes down over your purchase period.  And in the second case your gain is around 35.3%.  More importantly, in the second scenario, you were able to put in more money, which means you were able to make more money.  So, it is actually a lot better for the stock price to go up over the period.  If it always goes up, you'll always end up being able to buy $21,250 which is the same as saying 15% off the $25K limit.