Disclaimer: All material provided at DigitalNomadQuest.com is for informational purposes only and is not to be taken as financial advice or recommendation.
If you’ve ever been offered the chance to participate in the company ESPP plan, you might be familiar with how utterly terrifying the notion can be for someone who has never had to deal with it. For me, I had to conduct research before I even understood what an ESPP was. After doing said research, I decided that these seemingly simple plans can actually be a big benefit – and I was going to participate.
If you’re wondering what an ESPP is and how you can make the most of it, read on! We’re about to go down the rabbit hole of ESPPs.
Should You Participate in Your Company’s Employee Stock Purchase Plan (ESPP)?
What are ESPPs?
ESPPs are complex. However, they can most adequately be described as a type of benefit that employers can offer employees. Essentially, they enable employees to purchase company stock for a discounted rate. This rate means that those who contribute can get up to 15% off of the regular stock price.
A company might offer this benefit as a way to incentivize working for the company, with the assumption that purchasing a piece of stock will result in you, the employee, working for the company long term.
ESPPs are usually contributed to by the company automatically withholding a percentage of your pay based on your income. Most of the time, this number is between 1 to 10 percent of your paycheck.
The funds are withheld for a certain term: 3, 6, or 12 months. After this term, the funds are used to buy your part of the stock.
The funds are withheld until a certain term is met, typically three, six, or 12 months. At that time, the funds are used to purchase your company stock. The purchase price of your stock is usually the price that the stock was at when you first started contributing or the price that it was at when you purchased your shares – whichever is lower is the price point.
Then, from here, you can choose to purchase or sell your stock.
When to sell your stock
When you want to sell your share is your choice. Although, I personally like the idea of selling them as soon as you can. This, by most people’s standards, is called “flipping”. Flipping reduces the risk of holding onto a ton of company share and simultaneously seems to “lock in” the 15% gain.
Occasionally, the ethicality of flipping is questioned. However, most companies do and will validate the practice for you, so don’t be too worried if this is what your end goal is. In fact, the company I deal with promotes the idea and process of what they call the “ESPP Quicksale”.
ESPP Tax Implications
There are tax implications for almost everything. For ESPPs, this is true, too.
Your ESPP contributions are usually withheld from your AFTER-tax paycheck. This means that, in this case, the implications are null and non-existent. After the period comes to a close, you own your stock and there is no tax there, either.
Tax comes into play when you decide to sell your stock. If you purchased your stock less than 1 year before you decide to sell, you’ll be eligible for what’s called the “disqualifying disposition”, where your employer lists the gain of the sale on your personal forms and papers as regular income.
If it has been over a year, part of the gains would be considered long-term and capital.
How to make the most of your ESPP
Every company’s plan varies, but most ESPPs follow a general set of regulations and have close to the same benefits. This being said, you can make the most of your ESPP contributions by doing the following.
Make the maximum contribution.
It goes without saying that the more you invest, the more you get in return. With ESPPs, the more you invest, the more you get as a return when and if you decide to flip. Contributing the maximum is easy: all you have to do is contribute at your plan’s maximum level.
Flip.
Flipping, as we said above, is a great way to earn from your ESPP. Once you get to the end of your term and have purchased your shares, you can turn around and sell your stock immediately. This”flip” reduces risk. To further reduce your risk, though, you could try to short sell your stock just before the term is up; this could reduce your risk even further.
Make a goal.
Having an end goal is a great way to do everything in life. Want to squeeze into those old jeans? Set a goal to lose 20 pounds. Looking to buy a home? Prioritize your funds and make a goal to save a certain amount of money by a certain date.
This works the same way with the return from your shares. When you first start investing and before the shares are even purchased, set a goal for the money you’ll receive back when you sell. Having a concrete goal will help you to contribute without hesitation and with diligence.
Get expert advice.
If you need help, are worried about how ESPPs will affect your financial goals, or are simply wanting to get a second opinion, it won’t hurt to consult an expert. A financial professional will be able to answer all of your ESPP questions and steer you in the right direction.
Use other savings for your ESPP.
If you have a retirement savings plan, a general savings account, or any other accumulated income, it may be a good idea to consider putting some of that cash towards your ESPP. Remember, you can also flip the stock and then return the money to your original account, which will likely increase in balance due to the whole process. Bonus!
Some employers will allow you to redirect any future pay raises to your ESPP. This way, the pay raise doesn’t affect your lifestyle but is also put towards a good cause.
Common ESPP Mistakes
Mistake #1: Allowing ESPP options to expire.
When you’re granted a stock option, it is the opportunity to buy a certain number of stocks at a certain price. This, by most, is known as the strike or exercise price. You’ll also get a schedule for these options. Generally, the schedules have time frames of one to four years. Some, however, can have timeframes of validity that go up to 10 years!
You want to consider your stock options when they are “in the money” or “in the green”. This fancy term only means that during this time, the stock trades above its original strike price. As an example, I was given the option to buy stock at $120 per share. If my stock was trading for less than $120, it would be “out of the money”, whereas if it was trading for over $120, it would be “in the money”.
Mistake #2: Being unaware of stock rules that apply to leaving the company.
Stock expiration dates will quickly go out the window if you get laid off, quit, or retire. Regardless of your reason for leaving, it’s super important not to ignore your stock options when going through the transition. Many companies have a stock rule that gives you 60 to 90 days to exercise any stock options you may decide on. This can limit the amount of tax that you save and can set you up for a ton of taxation should you be forced to exercise a career’s worth of stock options within a single year.
Mistake #3: Forgetting about your company’s ESPP.
A striking number of employees forget about their company’s ESPP altogether. This can be because of financial limitations, or for other personal reasons, but it’s truly a shame either way. When you have generous discounts available to you, it would make sense to look into the idea more, right? Right! SO don’t forget.
By ignoring your ESPP you could be passing up a great opportunity to build your personal net worth. The offered discounts you take advantage of also give you a bit of extra padding, in that for you to lose money, stocks would likely have to go down at least 15%.
Are ESPPs worth it?
That is the million dollar question. Luckily, the answer is relatively simple.
Yes! Unless your company is drowning in debt and bad fortune, it’s generally a good idea to contribute to the ESPP.
Hope you enjoyed this post, and leave a comment if it helped!
