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The Benefits of Employee Stock Purchase Plans

The Benefits of Employee Stock Purchase Plans

October 18, 2022

In an effort to retain their top talent, many employers will offer Employee Stock Purchase Plans (ESPPs) to their employees. It’s a dual incentive. It shows how much your employer values your presence, but also, it’s a way for you to show belief in your company’s mission by investing with the company.

When an employer offers ESPPs, they are making it possible for employees to purchase shares in their company at a discounted rate. The discount can range from anywhere between 5% to 15% of the fair market value of the stock.

How it Works?

Typically, an enrollment period occurs twice a year. If you enroll, an ESPP account is created for you and much like 401(k) contributions, your account will be funded directly from your paycheck. Then every six months, the money saved in that account will be used to purchase stock in your company. This is known as the purchase period.

Contribution Limits

There is a limit to how much you can spend when buying up shares in your company. This limit is set by the IRS and, as of November 2022, that limit is $25,000 per calendar year. Of course, this is pre-discount. Something to consider is that your company may have its own dollar limit for contributions that is below the IRS limit. Often, companies will cap contributions from your paycheck. For example, they may limit your contribution to only 10%-20% of your salary that can be funneled to your ESPP account.

Benefits

There are quite a few benefits to entering an Employee Stock Purchase Plan:

The Lookback Provision

ESPPs will allow you to “look back” when purchasing shares. If the price of the shares is lower on the offering date compared to your purchase date, you would be able pay the lower price from the offering date. In fact, your discounted rate offered by the company would be applied to the lower rate as well. This obviously helps to minimize losses and maximize gains, depending on the health of the stock market.

Supplement Cash Flow

Despite your paycheck taking a hit when you enter an ESPP, you will see gains once you get through the first purchase cycle. If your plan is properly managed, you could end up with more after-tax pay compared to not even participating in the plan. You’ll see this as soon as the shares vest.

Near-Term Goals

The rate of return from selling vested ESPP shares may be higher than today’s highest-yielding savings accounts. Any short-term goals — buying a house, renovations, longer family vacations — are now more possible.

Investing

Investing in your future gets an injection of cash flow. Your portfolio will benefit greatly as compounding your ESPP can add up quickly. If you define the role of your ESPP stock in a financial portfolio, you will have flexibility to build a well-diversified plan.

Taxes

Of course, taxes come into play when discussing stock purchase plans. Purchasing shares will not include any taxes. You will only incur taxes when selling your ESPP shares. The question is how much you will pay in taxes and that’s dependent on when you sell your shares.

Tax planning boils down to two different types of shares. There is a waiting period associated with your shares, to allow them to fully vest, hence why you may hear the phrase: Qualifying vs. Disqualifying.

Disqualifying Position

If you sell your shares as soon as you purchase them. You are selling them from a disqualifying position. Any gains from the sale will be taxed at ordinary income tax rates, which are generally higher than most. You will also pay any applicable state and local income tax.

Qualifying Position

If you hold onto your shares for two years after the offering date, and one year after the purchase date, you would now be selling those shares from a qualifying position. The gains made from any sale would be taxed at lower-term capital gains rates. These are usually lower than the income tax rates you would’ve paid when selling from a disqualifying position.

What are your options?

It really depends on your tax situation. If the gains are significant, then maybe waiting to sell would have a bigger impact on your portfolio. But if you hold onto the shares and they fall in price, any tax savings will be washed out. A case can also be made to sell your shares right away to diversify your portfolio.

Reminder

It’s also important that you should speak with a *tax-planner before making any decisions. They would have the insight and knowledge about your options with regards to qualifying vs. disqualifying positions. I’m also here to help guide you on your journey, so please feel free to reach out if you have any questions about ESPPs and other equity compensation concerns.


*Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. Barnum Financial Group. 6 Corporate Drive, Shelton, CT 06484, Tel:(203) 513-6000

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