ESPP Worth It?

[abliviax]

My company (Oracle) offers ESPP w/ discount of 5%, up to 10% of paycheck.

I'm at approx. $100k * 10% * 5% discount is $500 dollar BEFORE tax that I'm leaving on the table, that isn't guaranteed or anything.

Am I missing anything - or is this a pretty mediocre benefit which may as well be passed up? -- and not have to deal with selling/stock risk/taxes.

Thanks!

[sulaco]

What do you mean it isn't guaranteed? Often ESPP _are_ guaranteed. When I worked at a large consulting firm, our ESPP allowed us to buy stock at a 10% discount of the lower price of the start or close of the window ESPP window. It was a guaranteed minimum 10% return for a quarterly investment that could be sold immediately. Generally returns were closer to 15% despite the stock being relatively stable, due to market fluctuations around the time of the opening or closing of the window.

When is the stock purchased (per paycheck, at the end of some window)? When is your price set - at the beginning of the window, end of the window, some other function?

[seattlecyclone]

ESPPs can be a good deal. My wife's employer offers one where you buy shares every six months. The price you pay at that time is 15% off of either the current market value or the market value six months ago, whichever is lower. So if the stock went from $30 to $40 in the past six months, you pay 85% of $30 ($25.50, or 36% off the current price). That's a great deal. If the stock went from $40 to $30, you still get a 15% discount off the current price. If you hold on to the shares long enough (18 months in the case of her plan; your employer could be different), any profit you make on the sale is taxed as a long-term capital gain rather than as wage income. We have built up sort of a "pipeline" of ESPP shares, buying the maximum allowed every six months, holding each lot of shares for 18 months, and then selling them once the holding period for favorable tax treatment is met. We have made a good amount of money this way in the past few years since the market has been going up. We'll probably lose a bit when the market goes down, but such is life in the market.

I wouldn't suggest tying up a sizable percentage of your net worth in your employer's stock. If you're in a debt emergency, don't have many assets yet, or don't have much confidence in the health of your employer, you'll probably want to just sell the shares right away to lock in the gains rather than using the pipeline strategy.

Your employer's 5% discount is much less enticing than the 15% discount, especially if there's no "lookback period" that lets you buy at a discount off the price six months ago if the stock went up. Might as well take the free money if you're allowed to sell right away, but it's not as great of a deal as other ESPPs.

[thesinecure]

why wouldn't you do this?

any of these plans i've ever been part of let you buy at the discount and sell whenever you want, or within a pretty short period of time

what are your holding restrictions, if any?

[MDM]

I'm at approx. $100k * 10% * 5% discount is $500 dollar BEFORE tax that I'm leaving on the table, that isn't guaranteed or anything.

Am I missing anything - or is this a pretty mediocre benefit which may as well be passed up? -- and not have to deal with selling/stock risk/taxes.

Depends on the definition of mediocre.  If it takes you 20 minutes to sign up, 20 minutes to sell, and 20 minutes to include in your taxes, that's a pre-tax $500/hr. 

[Badass by 41]

I had an ESPP at a former employer: 2yr look back; 4 x 6mo contribution periods; 15% purchase discount; 15% max paycheck contribution. My experience was similar to seattlecyclone in that I never saw less than a 10% ROI every 6mo, and often much larger.

I'm going to assume you have a similar plan at Oracle.

Provided you are already maxing out your tax deferred/exempt accounts, here's what I would do (which is what I used to do).

1) Save 10% of your gross income in cash ($10k in your case) to "float" your monthly finances
2) Max your ESPP contribution
3) Use your "float" to offset the reduction in each paycheck
4) Same-day-sale your ESPP on the first day you can
5) Pocket your $500+ ROI and use the $5k returned in principle to "float" your next ESPP period
6) Lather, Rinse, Repeat

There's an extra $1000+/yr in your pocket, and probably more in practice.

Unless you know of a 6mo CD paying 5%+, seems like a pretty good deal to me.  8)

Note: I personally used a portion of my liquid emergency fund as my "float" amount, which was in a high yield checking/savings account.  That meant I was still making some money on my "float", and not actually doubling my principle requirement.

[TheMadRussian]

If it's not money you'd miss I'd probably do it. Each ESPP period is less than a year so it's a slightly higher rate, annualized, than the 5%.

Worth noting: I believe that program calculates the discount you pay based on the price at end of the period vs. the lowest price during the period like many ESPP programs.

[msilenus]

If it's not money you'd miss I'd probably do it. Each ESPP period is less than a year so it's a slightly higher rate, annualized, than the 5%.

This is what's key, but the rate is more than slightly higher.  If your holding period is 6 months, then the average amount of time a dollar is sequestered in the ESPP account before purchased is 3 months.  Your first dollar is held for 6 months, but your last is held for zero months.

What does a 5% return over 3 months annualize to?  20%.  You won't find a better no-risk return without shifting to an employer with a better ESPP, and even much more volatile options will usually underperform an ESPP with even this mediocre discount.  Compare with CD rates.

Two real problems with an ESPP:
1) Trying to hold the stock leads to a catch-22: if you do that, and practice buy-and-hold, you'll wind up ridiculously overexposed to your employer.  If you try to minimize your exposure to your employer by selling after a couple of years, your best case scenario is taking on tax overhead from extra taxable events.  Better to just sell right away and diversify immediately.  You'll owe taxes on the discount either way, and the benefit for holding for 2 years is really tiny.  Just be sure to sell it right away every time.
2) The tax rules are needlessly complex.  I don't know about your brokerage, but ours doesn't report cost basis correctly on 1099s.  Even though we pay taxes on our discount as income, the cost basis winds up reflecting the discounted purchase price.  So we need to unscrew that manually when filing to avoid getting double taxed on the discount.  Usually just adjusting the cost basis in the obvious way is correct, but if there's a loss, then the stock price at the beginning (!) of the offering period can become relevant, even though it really shouldn't matter.  Your HR folks should be able to provide you with some assistance, like historical quotes, and probably some limited guidance on reporting proceeds from disposed ESPP shares.

You are right that your upside is only $500/yr, but I still think it's worth it.  You only have to learn how to navigate the paperwork once, and $500/yr adds up over the years.

[ichangedmyname]

I just enrolled this month for ESPP. 15% discount, look back feature and it's quarterly. I have to hold the stocks for a year before I can sell. Right now I am doing 5% on that. Should I instead add 5% to my 401k which is currently at 8%?

[Roland of Gilead]

If your company allows it you could short an equal amount of stock that would be in your ESPP at the end of a period if you think the stock has peaked during the period or you need to lock in gains earlier. 

Say you get 10% off at either the start or end price and you short the stock in the middle when it is 30% higher than the start price.  You have locked in a 40% gain with no risk.

[foobar]

ESPPs require you to look into all the details
1) How long is the look back period? In the old days it used to be 2 years and you got the lower price at either the start or the end of each 6 month period and once an offering started you could be buying at the price from 2 years ago. It was like printing money when you bought the stock at 5 dollars and flipped it a day latter at 50. I put off leaving a company for 7 months because that was worth about 60k.

2) Can you withdrawal during the period. We used to be allowed to opt out at any time. You just got your money back

3) When can you sell. Having to hold a year sucks.

Personally I think you choice between this and a 401(k) is wrong. ESPP are short term. You should never be leaving money in company stock (yess you make a killing when it works out but in general the risk is too high).  You buy the ESPP and flip it 6-12 months later. If your optimistic you hold for the LTGC treatment.  It is not so much as an investment as a slight delay in when you get your money. You should still be maxing out your 401(k).

I just enrolled this month for ESPP. 15% discount, look back feature and it's quarterly. I have to hold the stocks for a year before I can sell. Right now I am doing 5% on that. Should I instead add 5% to my 401k which is currently at 8%?

[msilenus]

I just enrolled this month for ESPP. 15% discount, look back feature and it's quarterly. I have to hold the stocks for a year before I can sell. Right now I am doing 5% on that. Should I instead add 5% to my 401k which is currently at 8%?

My notes above are targeted at ESPPs like the OPs.  Your minimum holding period is a game changer, with respect to that analysis, because it's impossible for you to use your ESPP to approximate a zero risk rate of return.  The look back feature makes yours potentially much more lucrative, but it's still a different kind of animal.

I suspect what's best for you will wind up boiling down to a number of personal factors including your marginal tax rate (lower is better for ESPP,) your personal risk tolerance and psychological capacity to handle volatility (higher is better for ESPP), your net worth (higher is better for ESPP because it allows you to tolerate having more dollars tied up in your employer without skewing your overall asset allocation as much), your company's medium-term prospects (stable or better is better for ESPP,) and perhaps other factors.

Personally, if I had a great ESPP with a steep discount and lookback feature at a basically stable employer, I'd probably max it out almost no matter what else was going on in my life.  Maximize expected value, and shrug it off if it doesn't pan out.  But then again, I approach a lot of things that way, to the point where I sometimes come off as reckless to other people, and know from experience that I can deal with losses.  YMMV.  A lot.

[cambridgecyclist]

What do you mean it isn't guaranteed? Often ESPP _are_ guaranteed. When I worked at a large consulting firm, our ESPP allowed us to buy stock at a 10% discount of the lower price of the start or close of the window ESPP window. It was a guaranteed minimum 10% return for a quarterly investment that could be sold immediately. Generally returns

  Math note: a guaranteed 10% discount is a guaranteed 11% return.

[rl2]

I max mine out at 10%, and sell after holding 1yr for long-term capital gains. Some say to sell immediately after deposit for diversification, but I'll take the risk for a smaller tax cut.

Guaranteed return plus another mechanism to force you to save.

[Roland of Gilead]

We sell immediately because owning your company stock is about the worst case of diversity (How would you like it if your company stock sharing plan was at Radio Shack?)

[msilenus]

I max mine out at 10%, and sell after holding 1yr for long-term capital gains. Some say to sell immediately after deposit for diversification, but I'll take the risk for a smaller tax cut.

Guaranteed return plus another mechanism to force you to save.

This doesn't actually work.  The discount you get is income, not capital gains, so holding for longer doesn't reduce it.  (Unless you're paying taxes on it twice because your brokerage isn't reporting cost basis correctly.  In that case, the right move isn't to pay a lower LTCG rate on the second tax your paying on the same money.  It's to understand the correct cost basis calculation, and start paying taxes on the discount amount only once, eliminating capital gains taxes entirely.)

Do the "sell immediately" thing right, and you wind up paying ordinary income on the gains (you pay that either way), and capital gains or losses on maybe a few hours or days on the stock itself, which should usually wind up approximating zero.

[Roland of Gilead]

This doesn't actually work.  The discount you get is income, not capital gains, so holding for longer doesn't reduce it.  (Unless you're paying taxes on it twice because your brokerage isn't reporting cost basis correctly.  In that case, the right move isn't to pay a lower LTCG rate on the second tax your paying on the same money.  It's to understand the correct cost basis calculation, and start paying taxes on the discount amount only once, eliminating capital gains taxes entirely.)

Indeed, I didn't catch this on our taxes until 2009 or so.  We had been double paying taxes on the discount amount because it was hidden but reported as wages on our W2 and it was not included in the basis on our 1099.  I was able to correct 2006, 2007, 2008 to get about $2000 total back but we had been doing it wrong since around 1996 meaning we paid Uncle Sam about $5,000 in double tax that he refused to give back.

Funny that the company still reports it incorrectly on the 1099.  I bet half the employees at our company still pay double tax.

[msilenus]

Only half? 

Unlikely, I think. :)

[MayDay]

I swear I am generally a smart person but the taxes on this is confusing the heck out of me.

Dh gets a 15% discount on the lowest price during the 6 month period, and can sell immediately. For the first period, which ended in Dec, he held onto it all until spring as the company's stock is typically higher every spring. Going forward we are debatingselling immediately vs. holding until spring and selling the year's worth each spring.

We obviously need to figure out the taxes first, though, as I am sure we have been doing it wrong.

[abliviax]

Mayday -

I believe if you have a $100 security which your employer discounts to $85, you will have to pay taxes on income of this 15% ($15/share).

If you have/chose to hold until it goes up to $110, you will have to pay capital gains taxes on the $10 gain.  (Around 15% if you hold for more than a year more like 25% for less).

You paid $85, your employer paid $15, and when you sell for $110 your cost basis is $100.

[Roland of Gilead]

You paid $85, your employer paid $15, and when you sell for $110 your cost basis is $100.

They then put the $15 your employer paid on your W2 as regular wages and the brokerage house that handles your employer ESPP sends you a incorrect 1099 that says your basis is $85 instead of $100.

(this is what has happened for the last 16 years at our employer)

[msilenus]

The laws can be a bit more complex.  If you hold for long enough, and still take a loss, then there can be some favorable tax treatment.  Oddly, the treatment can depend on a price that has nothing to do with either the discounted or fair-market purchase value.

It's strange.  I personally haven't seen anything weird happening (incorrect 1099s notwithstanding) from just selling right away.

[rl2]

Interesting, I'd been thinking of the discount incorrectly as a gain rather than income. Thanks for the info @msilenus

[MrMoneyMustache]

@abliviax - what did you decide? Is it worth it?