Evaluating The Pros And Cons Of Your Employee Stock Purchase Program

Many publicly traded companies offer employees the chance to purchase discounted company stock at regular intervals through an Employee Stock Purchase Program (ESPP). While some of your coworkers may be telling you this is a no-brainer and amounts to free money, others may be cautious and opt not to participate in the program at all. This is how to weigh the benefits and drawbacks of the ESPP offered by your employer.

How ESPPs Work

To understand your company’s ESPP, you should read through your program’s unique rules prior to participating. This is a general overview of how ESPPs work.

Over time, you as an employee can choose to have a percentage of your paycheck set aside for purchase of company stock. The most common discount I see is 15% but the discount amount can be less. If your stock is available at a 15% discount, you can purchase $1,000 worth of stock today for $850.

Oftentimes, ESPPs come with holding period of six months though this can vary as well. This would mean that you couldn’t sell immediately to cash in on the 15% discount. You’d need to wait out the holding period to be able to sell.

Benefits

If you are a big believer in your employer and their mission and would be purchasing stock in the company regardless of the discount, it makes sense that you’d want to participate in the ESPP. You get the opportunity to participate in the growth of your company and you may even see your own hard work reflected in that price movement. Even if you’re not particularly bullish and you just think the stock will be flat, you can benefit from participating in the short run due to the discount.

Risks

The biggest risk when it comes to ESPPs is concentration risk. Single stocks are much more volatile than the overall market, and they run the risk of their value reducing to $0. Since contributions to the program are automatic but sales of the available stock are not, many people end up with a significant amount of their net worth tied to their employer. Both your income and your personal investments are wrapped up in one company in that case.

Let’s say that most of your net worth is in company stock and your employer begins to undergo some financial trouble. They end up laying you off. Most likely, their stock value would be taking a dip as well. In one fell swoop, your net worth and income would all be significantly reduced, potentially forcing you to sell stocks at a low point to make ends meet.

Taxes

Your ESPPs will be subject to capital gains rates based on how long you have held the stock since your purchase date. The discount you receive will be considered income if you sell the stock within two years of the date the ESPP was offered to you. You may choose to hold onto the stocks for at least two years to receive favorable tax treatment on both your discount and gains. This favorable bracket is known as long term capital gains and has a maximum federal rate of 20%.

If you sell your stock within one year, your gains and the discount would be subject to short term capital gains, which are taxed at your ordinary income tax bracket. If you sell between more than one year after your purchase but within two years of the offer date, you receive ordinary income taxation on the discount and long term capital gains on any additional gains.

Let’s say you bought $1,000 work of company stock for $850. You held it for a full two years from the offer and at least one year after purchase. If the stock value had appreciated to $1,200 when you sold it, you would pay long term capital gains taxes on $350 when you sell.

Many people ask me if it is always best to wait at least a year. The answer is a resounding no. If your stock has minimal gains, is flat, or is down, it may end up making sense to sell before one year has passed, depending on your financial goals and tax situation.

Costs

Some banks that house ESPPs charge significant commissions on the sale of stocks, even if you’re the one handling the trades yourself. This can make it difficult and costly to sell on a regular basis and may erode the benefit of the discount. Let’s say you put $255 into your ESPP to purchase stock at a 15% discount. If the stock was flat between the day of purchase and day of sale and you had $300 in stock value, you could end up paying a $35 commission on the sale for a grand total of $10 take-home profit.

Practical Advice

When you are thinking about whether to participate in your employer’s ESPP, it is important to consider your personal financial goals, tax situation, existing investments, and tolerance for risk. The ESPP may be an attractive offering, but it’s important to weigh the benefit of the discount with the taxation, risks, and associated costs.

I often tell clients that if they hold a single concentrated stock, they must be okay with that portion of their portfolio potentially going to $0 as much as they hope the stock will boom. When we want more stability and predictability of returns, I advise clients move from the single stock concentrations to diversified portfolios invested according to their risk tolerance.

This article was originally published by me on Forbes.

This informational and educational article does not offer or constitute, and should not be relied upon as, tax or financial advice. Your unique needs, goals and circumstances require the individualized attention of your own tax and financial professionals whose advice and services will prevail over any information provided in this article. Equitable Advisors, LLC and its associates and affiliates do not provide tax or legal advice or services. Equitable Advisors, LLC (Equitable Financial Advisors in MI and TN) and its affiliates do not endorse, approve or make any representations as to the accuracy, completeness or appropriateness of any part of any content linked to from this article.

Cicely Jones (CA Insurance Lic. #: 0K81625) offers securities through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC (Equitable Financial Advisors in MI & TN) and offers annuity and insurance products through Equitable Network, LLC, which conducts business in California as Equitable Network Insurance Agency of California, LLC). Financial Professionals may transact business and/or respond to inquiries only in state(s) in which they are properly qualified. Any compensation that Ms. Jones may receive for the publication of this article is earned separate from, and entirely outside of her capacities with, Equitable Advisors, LLC and Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC). AGE-6745064.1 (07/24)(exp. 07/26)