Author Topic: Should I get stock options at a discount or save that money?  (Read 4500 times)

melanie2008

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Should I get stock options at a discount or save that money?
« on: April 15, 2015, 06:25:28 PM »
My company offers stock options at a 15% discount. Once you buy it, you can keep it or sell it right away. Should I do this? Makes more sense to put in the 401K to lower taxes though (25% tax bracket). Is my logic correct? I initially thought it was a good idea, but it probably isn't unless I just wanted to keep some as a stock in general. Thanks.

MDM

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Re: Should I get stock options at a discount or save that money?
« Reply #1 on: April 15, 2015, 06:31:52 PM »
My company offers stock options at a 15% discount. Once you buy it, you can keep it or sell it right away. Should I do this? Makes more sense to put in the 401K to lower taxes though (25% tax bracket). Is my logic correct? I initially thought it was a good idea, but it probably isn't unless I just wanted to keep some as a stock in general. Thanks.
After you use all your tax advantaged space, running your money through the ESPP on its way toward a diversified investment is a great idea.

clifp

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Re: Should I get stock options at a discount or save that money?
« Reply #2 on: April 15, 2015, 06:40:38 PM »
This is one of those things where terminology is critically important.  I suspect what your company offers is an Employee Stock Purchase plan (aka ESOP) which lets your purchased company stock at a discount.  In general these are fantastic deals and often can have an interest rate (technically internal rate of return) that is in excess of 100% (and no that isn't a typo.)  The details matter on if it it is a good or an amazing deal.

However you said stock options which is whole different type of investment opportunity and can be very complicated to figure it out.

I'd suggest checking with your HR department on the exact details and posting them.

skyrefuge

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Re: Should I get stock options at a discount or save that money?
« Reply #3 on: April 15, 2015, 07:07:56 PM »
This is one of those things where terminology is critically important.  I suspect what your company offers is an Employee Stock Purchase plan (aka ESOP) which lets your purchased company stock at a discount.

I agree that the terminology is critical here, and agree that it's likely an "Employee Stock  Purchase Plan" (ESPP) is what the OP is actually talking about. And that's why I must point out that your use (probably a typo) of the acronym "ESOP" is incorrect. An ESOP (usually "Employee Stock Ownership Plan") is something quite different than an ESPP, and both are different from "stock options" (ISOs, NQSOs, or even RSUs)

http://en.wikipedia.org/wiki/Employee_stock_ownership_plan
http://en.wikipedia.org/wiki/Employee_stock_purchase_plan
« Last Edit: April 15, 2015, 07:10:33 PM by skyrefuge »

melanie2008

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Re: Should I get stock options at a discount or save that money?
« Reply #4 on: April 15, 2015, 08:06:04 PM »
I had no idea that there were differences! I am very new to all this. It is an ESPP. I will try to find out more details when I start. Thanks!

GreenPen

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Re: Should I get stock options at a discount or save that money?
« Reply #5 on: April 15, 2015, 09:05:24 PM »
I don't see why your ESPP would cause you to contribute less to your 401k. Even if you need to decrease your ongoing 401k contribution amount to participate in the ESPP, couldn't you just increase your 401k contribution around the time that you sell your shares (assuming that your plan allows you to sell sometime this year)?

melanie2008

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Re: Should I get stock options at a discount or save that money?
« Reply #6 on: April 15, 2015, 09:25:32 PM »
I don't see why your ESPP would cause you to contribute less to your 401k. Even if you need to decrease your ongoing 401k contribution amount to participate in the ESPP, couldn't you just increase your 401k contribution around the time that you sell your shares (assuming that your plan allows you to sell sometime this year)?

I was thinking that since I am not maxing out my 401K (have too many student loans to do so at this time), it is best to stick everything I can in the 401K (10% + 4% matching) since it is pre-tax (save 25%) versus only saving 15% on the ESPP. The ESPP allows me to sell them anytime even right after I buy them.

seattlecyclone

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Re: Should I get stock options at a discount or save that money?
« Reply #7 on: April 15, 2015, 09:43:23 PM »
Definitely contribute enough to the 401(k) to get the maximum match. After that, contribute to the ESPP. After you buy your first shares, sell them right away. At that point you can pay some of your bills with the proceeds from your ESPP sale, which should allow you to divert more of your paycheck into the 401(k).

terran

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Re: Should I get stock options at a discount or save that money?
« Reply #8 on: April 15, 2015, 09:45:10 PM »
If you can sell them right away then you can just buy then sell and turn around and put money in your 401k after getting an instant 15% return (less the taxes you'll pay on the short term capital gains), so it seems like there's no loss other than whatever time it takes you to do the buying and selling.

On second thought, both 401k and ESPP probably have to come out of payroll deductions, huh? In that case, it probably makes the most sense to contribute as much to your 401k as you can/plan to, then buy as much stock through the ESPP as they'll let you (there's probably a limit because they still need to withhold taxes) even though you need some of that money to live off of (since it's only until you sell anyway), sell it right away and enjoy the 15% "raise" on that income (less the short term capital gains).
« Last Edit: April 15, 2015, 09:56:06 PM by terran »

MDM

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Re: Should I get stock options at a discount or save that money?
« Reply #9 on: April 15, 2015, 10:13:56 PM »
If, as many have suggested, you can do both then do.  If you have to make a choice (e.g., if your money would be tied up in the ESPP too long for you to do both), here is one way to evaluate:

P = Pre-tax amount, $
i = investment return
n = years
t1 = current tax rate.  Also assumed to be the tax rate when the 401k is withdrawn....
t2 = tax rate on ESPP returns.  Note that this is irrespective of whether the money is left in the original stock or moved to another investment.
d = ESPP discount

401k value = P*(1+i)^n*(1-t1).  This is the usual formula for compounded returns from an investment which is taxed on withdrawal.

ESPP value = P*(1-t1)/(1-d)*(1-d*t1)*(1+i)^n*(1-t2).  Let's take this in pieces:
    P*(1-t1) = amount investable after tax
    P*(1-t1)/(1-d) = value of stock purchased
    P*(1-t1)/(1-d)*(1-d*t1) = amount remaining after taxes are paid on the ordinary income from the ESPP purchase.  Note: this is the ESPP I'm familiar with - seattlecyclone may provide a different formula for another type of ESPP.
    P*(1-t1)/(1-d)*(1-d*t1)*(1+i)^n*(1-t2) = The usual formula for compounded returns from an investment which is taxed on withdrawal.

Divide the 401k equation by the ESPP equation to get (note that P, i, and n are irrelevant):
    (1 - d) / ((1 - d*t1) * (1 - t2))

For values
    d = 15%
    t1 = 25%
    t2 = 15%
the 401k route is ~4% better.

As always, different assumptions may lead to different results.  Aka YMMV.


clifp

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Re: Should I get stock options at a discount or save that money?
« Reply #10 on: April 16, 2015, 12:58:49 AM »
Actually in most cases you are better of borrowing money on a credit card and maxing out  participating in an ESPP..

Here is an example. Lets say the stock is selling for $23.52 which after your 15% discount means you can purchase it for $20 share.
The stock is purchased every 6 months. (Some plan like the one I was in gave you a 15% discount at the lower of the price at the beginning of the 6 months period or at the end.) But lets assume your just operates at the end of the pay period.


Every pay period you contribute $200 month at the end of 6 months you contributed $1,200 which means you have enough to buy 60 shares you sell the shares at $23.52/share leaving you $1411 or $211 in profit.

Now lets assume you don't have an extra $200 month so you have to borrow on a credit card at 18% interest or 1.5% per month.  The first $200 will cost $3/month for 5 months (there is a month grace period) the 2nd month you borrow another $200 for 4 month, 3rd month 3months etc. Your total interest is cost is $15+$12+9$+$6+$3 (ignoring the tiny amount of interest on interest) or a total of $45 to make $211 in profit.  You'll have to pay taxes on the $211 of say 30% but even after taxes and interest you'll still be ahead by about $100.  Plus you can do this twice a year. Which mean you can make $200 on a maximum investment of $1200 which is a phenomenal rate of over 16%.  Plus in most plans its practically guaranteed.

There are only two investment which are worth going into credit car debt for employee match on a 401K and 90% of ESPP.   

melanie2008

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Re: Should I get stock options at a discount or save that money?
« Reply #11 on: April 16, 2015, 06:49:37 AM »
Ok. You have convinced me! I have some extra to play around with since it is extra to go towards student loans so shouldn't be a problem. I just like paying off bills ASAP. I will stick to my original plan. I will start with $100/month and see how it goes and then increase later. Thanks!

GreenPen

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Re: Should I get stock options at a discount or save that money?
« Reply #12 on: April 16, 2015, 10:08:28 AM »
melaniesuzanne - for what it's worth, my wife and I are in a very similar situation. We both have student loans, but her company offers an incredible 401k match (50% match up to IRS maximum), along with what sounds like a similar ESPP. We participate in the ESPP up to the max, and pay off loans when we sell right away.

Also, your company might offer a 15% discount on the lesser of the stock price on the first or last day of the offering period. If that's the case, then you might get an even greater discount.

ysette9

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Re: Should I get stock options at a discount or save that money?
« Reply #13 on: April 16, 2015, 10:17:13 AM »
My husband's company offers a very similar stock purchase plan with the six month wait period to sell. We are participating now and I view it as a guaranteed 15% return (or possibly more depending on what the stock price does) and the only cost to us is that we have to wait an for six months for the first "batch" to ferment. After that initial period it is just a rolling wave of contributing and selling what had accrued over the prior six months to move the funds into another investment vehicle. Put another way, we've added one more box in our flow diagram of how our money moves; it flows through an extra box earning 15% on its way from paycheck to Vanguard. Win!

frugalnacho

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Re: Should I get stock options at a discount or save that money?
« Reply #14 on: April 16, 2015, 10:20:41 AM »
Max that sucker out and sell it ASAP! ESPP are free money!  I have gone through my dads ESPP plan and he has made unreal returns because of the way the discount is applied.  I don't know if all ESPP are the same as my dad's, so you will want to verify how your specific plan works before taking the following advice as gospel.  The dividends generated get reinvested at the regular fair market price of the stock, so I would say absolutely set it up so that dividends do NOT reinvest and they just cut you a check instead.  You will have a withholding period of something like 3 or 6 month periods, where your employer will withhold 10% (or whatever you set it at) of your pay.  When the holding period is over they will look at the price of the stock on the first day of the period, and the last day of the period, and you get a 15% discount off of the lower of the two prices.  So you are purchasing the price at a minimum 15% discount.  If the stock increases in value during the withholding period you get 15% off the cheaper initial price.  If the stock decreases in value you still get it at 15% off the discounted price, and you won't have lost any value during the withholding period.  It truly is free money from your employer.

neil

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Re: Should I get stock options at a discount or save that money?
« Reply #15 on: April 16, 2015, 11:09:13 AM »
I will also agree if you can max out your 401K but can not do ESPP in the short term, find a way to make it happen.  Consumer debt may even be ok if you are careful and plan it out (and backload your expenses as much as possible).  Once you are past the first period, you can sell the shares and live off that while the next set of ESPPs are accumulating.

My company's stock is fairly flat, so we usually get ordinary returns most of the time.  However, volatility kicks in on occasion and it becomes a large windfall.  Even though 401K is still probably functionally better if you have to choose, I know people at work do not contribute to either.  Some people really don't like to see their take-home pay reduced to low levels, but they are really missing the big picture.  I would happily loan them the money for a portion of the profits if I could.

There is no withholding on the gains, so be prepared for an increased tax bill in April.

melanie2008

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Re: Should I get stock options at a discount or save that money?
« Reply #16 on: April 16, 2015, 09:31:31 PM »
All great info! Mine is 15% of the closing price on the last day of the quarter. I will max it out for the first quarter and see how it goes and see if I can figure out how to make the most out of it. You all make it sound pretty easy!

frugalnacho

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Re: Should I get stock options at a discount or save that money?
« Reply #17 on: April 16, 2015, 10:36:37 PM »
I will also agree if you can max out your 401K but can not do ESPP in the short term, find a way to make it happen.  Consumer debt may even be ok if you are careful and plan it out (and backload your expenses as much as possible).  Once you are past the first period, you can sell the shares and live off that while the next set of ESPPs are accumulating.

My company's stock is fairly flat, so we usually get ordinary returns most of the time.  However, volatility kicks in on occasion and it becomes a large windfall.  Even though 401K is still probably functionally better if you have to choose, I know people at work do not contribute to either.  Some people really don't like to see their take-home pay reduced to low levels, but they are really missing the big picture.  I would happily loan them the money for a portion of the profits if I could.

There is no withholding on the gains, so be prepared for an increased tax bill in April.

Yes.  If the stock is $100, and they sell it to you for $85, then your cost basis is $100 and that $15 difference counts as income that was paid to you in the form of stock. You do not claim that $15 income until the year to sell the stock though. If the stock price goes up and then you sell, $85 will go back to you as your money (it's already accounted for on your w-2), $15 will count as regular earned income, and anything above that will count as a capital gain.

MDM

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Re: Should I get stock options at a discount or save that money?
« Reply #18 on: April 16, 2015, 11:02:43 PM »
You do not claim that $15 income until the year to sell the stock though.
That is true for some companies, but not all.  Unfortunately "ESPP" is not a specific enough descriptor.

See http://forum.mrmoneymustache.com/investor-alley/employer-stock-options/ and links therein for some discussion about a couple of the more common(?) types of ESPP.