How employee stock purchase plans work
Typically offered to all employees, ESPPs can let you buy company stock at a discount of up to 15%, capped at $25,000 per year for tax-qualified plans.
The plan collects after-tax contributions from each paycheck during an “offering period” and uses the funds to buy company stock on a specific date.
“The gold standard for a plan will be a 15% discount with a lookback feature,” said Bruce Brumberg, editor-in-chief and co-founder of myStockOptions.com.
A “review” provision bases the purchase price of shares on the value at the beginning or end of the offering period, whichever is lower. For example, let’s say your ESPP offers a 15% discount and a look back. With a starting price of $20 and a closing price of $22, you get a 15% discount on $20, for a total savings of 22.7% per share.
According to Report 2022 by Morgan Stanley at Work.
What you need to know before selling your shares
While it may be tempting to cash in on your shares at a discount, there is complicated tax rules to be considered, including fees on the discount. The most favorable breakdown of regular income and long-term capital gains depends on when you sell.
Your employer may also require you to hold the shares for a certain period of time. “Some companies have an additional holding period requirement,” Brumberg said. “They don’t want you to change stocks.”
The gold standard for a plan will be a 15% discount with a lookback feature.
Bruce Brumberg
Editor-in-Chief and Co-Founder of myStockOptions.com
Of course, there are other key details to confirm in the plan document.
You want to know if the ESP is tax-qualified, what savings it can offer, as well as how to sign up, the length of the offer period, purchase dates, how to make changes and what happens if you leave the plan. , he said.
Check “all other boxes” before an ESPP
While a bear market can offer an even deeper discount, allowing you to buy more shares, there are other benefits to consider before piling on.
There’s no guarantee you’ll make a profit, because “stocks don’t always go up,” McKenna said.
In fact, most individual stocks do not outperform the market, according to a Analysis by JP Morgan. From 1980 to 2020, almost 45% of companies in the Russell 3000 Index suffered a 70% price drop from the peak and never recovered, the report shows.
Given these risks, experts may suggest an ESPP to supplement your 401(k), rather than as your primary way to save and invest. And you’ll still want to weigh your risk tolerance and goals before signing up.
An ESPP may be worth considering if you’re already meeting your other financial goals, such as maxing out your 401(k), investing in a brokerage account, paying down debt or other savings goals, McKenna said.
It might work once you’ve “checked all the other boxes,” he said, but it might be better to focus on other planning opportunities first.
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