De-Coding ESPP (Employee Stock Purchase Plans)

I love Employee Stock Purchase Plans. Depending on your employer's ESPP plan, you may be able to increase your annual income by 1% or greater.

Here are a few topics I cover:

• ESPP Basics
• ESPP with Look Back Provision
• ESPP Tax Treatment
• ESPP Strategies
• Risks of ESPP

YouTube Video
ESPP Return Calculator
ESPP Strategy Guide w/Cheat Sheet

Fort Collins Fee-Only Financial Planner

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So, why am I so excited about the employee stock purchase fight? It's because it's one way that you can potentially guarantee a rate of return with practically no risk. And you have to sell the shirts immediately, and I'll kind of talk through the mechanics of that. This is Techy Personal Finance Bootkit, where I help tech professionals in their 20s and 30s, and that's a great life to do without sacrificing their future possibilities. I'm your host, Lucas Caceres, certified financial planner and founder of Local Up Financial Planning, where I help educate, coach, and build strategies with my clients to help them take their financial confidence to the next level. Here's an important compliance disclosure. This podcast is for informational purposes only and they're not to be considered recommendations. It is recommended you consult your trusted financial professional before implementing any information obtained from the Techie Personal Finance Bootcamp. Hello, thank you for joining Techie Personal Finance Bootcamp. I'm excited to talk to you about a benefit that most employers offer, especially if they're publicly traded companies, which means that you can purchase your shares on the stock market. And it's called the Employee Stock Purchase Plan. And so the reason why I love this benefit so much is because it's one way that you can just kind of guarantee an increase of income, which there's not too many ways that you can do that. And depending on some of the futures that your employer builds into their plan, you can increase it by a sizable amount potentially. Which again, I'd have to say that probably varies as far as what sizable is, but in most situations, I see anywhere from one to two percent increase in your income potential just from this plan alone. And that's if it doesn't have some crazy feature, which I'll briefly mention because it if it you do have it, then it's more of a reason to partake in the employee stock purchase plan. So why am I so excited about the employee stock purchase plan? It's because it's one way that you can potentially guarantee a rate of return with practically no risk, and you'd have to sell the shares immediately. And I'll kind of talk through the mechanics of that when we get there. But uh basically that's how you can make this work where there's very little risk involved in a potential guaranteed return. And so how the employee stock purchase plan works is you have to opt into it typically. It's very rare if an employer is gonna force it on you or say you have to do this, but typically there's different periods of time where you can enroll in it, you can put anywhere from 1% to sometimes up to 15% of your income. This is gonna vary by your employer, as a lot of things I'm gonna mention in this episode today are. So you'll definitely want to review your specific documents. I'm gonna be talking about a few of the ranges and why this stuff is important and a reason for you to go and do that additional research if you need to. But yeah, typically you can put anywhere from one to 15% of your income. And what happens is that builds up over a certain time period, and once the time to purchase those shares comes around, the most common I see is every six months, you actually receive a discount on those shares. So if it the shares were $100 and you get a 10% discount, you're actually gonna pay $90 and receive something that's worth $100. And the cool thing is you can go ahead and sell it right away and try to lock in that $10 return. Again, that's a huge benefit because there you could do it quickly. You know that you're gonna get a return. You know this is always gonna work in your favor as long as you sell it right away. The other option is to hold on to the shares longer. If you think your employer is gonna be doing well, doing better than the overall stock market, then it might be a reason to hold on to the shares more long term. And we'll talk through a couple of those strategies at the end of the show. But yeah, the the range that your employer may offer a discount is anywhere from 5% to 15%. When it's in the 5% range, it makes it a little bit of a pain in the butt to do unless uh you have excess income and and you'll go ahead and do that anyways. But if you're gonna receive a 15% discount, that's where we're definitely talking about easily one to almost 2% guaranteed return or guaranteed increase for your income for the year. So it's pretty meaningful money and it's free money at that. Also, I want to add is there's actually a cheat sheet I created for the employee stock purchase plan. So if you want to follow along, just go to my website, go to the show notes, and pull up uh the PDF of the cheat sheet, and you'll be able to follow along mostly with how I'm navigating this discussion today. The biggest reason why a lot of people avoid the employee stock purchase plan. So the biggest one is because they don't understand it. Uh, the next one is because their cash flow doesn't allow it. They're already living paycheck to paycheck. So, how are they gonna defer 10% of their income to get this discount and increase their income? And I would say if that's one of your reasons, try to find a way to make it work because it is a huge benefit. And then the the last major item is the taxes. So they're like, oh, it's just another thing I'll have to pay taxes on. But one thing I want to remind you is that when you pay more taxes than you normally would, it's usually because of something good going on financially. So if you're if your income goes up, then you're gonna pay more in taxes. But once you net out the taxes, you're still better off for that additional income you make. So that's the same case with this as well. Um, there's also some unique tax treatments if you do plan to hold on to the shares long term, and we'll briefly discuss that too. But uh there's a few key terms when you're looking through your employer's documentation on your employee stock purchase plan. Again, this stuff varies a little bit from plan to plan. So I can't go into your specifics, but there's a few key terms, and so on the purchasing side, you're gonna be seeing terms that say like offering period, purchasing period, and look back provision, all important to know because that they affect when you're able to actually purchase the shares, when you have to enroll to be able to purchase the shares, and then the offering period and the purchasing period, all these things tie into some of the preferred or beneficial tax treatment that uh you had to meet certain qualifications for. So we'll talk through that a little bit more. I'm not gonna talk specifically about the offering period or purchasing period, but I'll just touch on that again in just a few minutes about how to qualify for that preferred tax treatment if that's something that you're looking to do. The look back provision, that's the craziest feature available. Um, it's kind of rare. I don't see it quite as often as I I wish I would see, but it still does exist, it's still out there. And why it's so cool is it gives you the ability to actually purchase your shares for even a greater discount uh than what most people may be able to. And so how it works is with these periods of time when you start saving into the bucket of money to purchase those shares. Typically six months is when I usually see it, but sometimes it's a year, it can vary by implor. But uh regardless, as you're saving the money and it's kind of going into that pot, that kicks off a certain time period. So that the beginning of that period is important to know because that value may potentially be looked back on to give you an even greater discount. So for this example, and it's definitely important to give an example with kind of working this out. So if we said that your company stock was worth $90 at the beginning of the purchasing period, and so you start saving and you're starting to accumulate all the money to purchase shares, six months goes by, which is what we'll be using for this example, and now those shares are worth $100 with the look back provision. It's actually better to purchase those shares back when that period officially started. So you'll be purchasing them at a $90 and receiving the discount from the $90. So a 10% discount, if that's how this employer is providing the discount, that would be a $9 saving. So you'll actually be purchasing the shares for $81 and then receiving shares that are worth $100. So that is a pretty ridiculous return on investment. So purchase shares for $81, they're worth $100. You sell them immediately. That's a $19 return on an $81 investment. So almost a 25% return, pretty significant. The other terms that you want to be familiar with, so on the sales side, there's a discount element, and that's what your employer is giving you in terms of free money. That's the discount you receive while you're paying way less on what the shares are worth. That is always going to be taxed as ordinary income. And we'll talk about that in a second. But the most important thing to know, and I'll say this again because it's so important later, but you actually only pay taxes once you sell the employee stock purchase plan, shares that you purchase. So if you're buying into the employee stock purchase plan and year after year goes by, you actually don't pay taxes on those things, except for maybe like dividends and things that kick out, but you don't pay the sizable taxes on it until you actually decide to sell those. I'm not going to go into it today because it gets tricky, but there's some advanced strategies you can do to lay in that tax burden into a future opportunity. Let's say when you decide to take six months off and travel the world or go into retirement or make some other different strategic move, that would be a good time to force that discount into that time period where your income and your tax bracket may be potentially lower. Another important term would be qualified disposition. And if there's a qualified disposition, then you probably guess that there's a non-qualified disposition as well. The qualified disposition is what you would want to achieve if you want that unique tax treatment. And it requires that you meet two things. So you actually have to hold the shares that you purchase from the employee stock purchase plan for greater than two years from the offering period and one year from the purchase period. So that's why those previous terms are meaningful and important if you do plan on holding the shares, uh, because you might want to try to qualify for this. The reason why that's important, and we'll talk to that in a second, but the the general reason is you get unique preferred tax treatment if there's capital gains associated with the sale of those shares. And so qualified disposition, non-qualified disposition, those things only matter when it comes to the sale when you're ready to sell those assets. So non-qualified because disposition means you don't get preferred tax treatment, and it basically means you just didn't meet both of those requirements in order to have that qualified disposition. So pretty straightforward there. Looking at the tax impact, again, I mentioned this is one of the reasons why people shy away from actually diving into the employee stock purchase plan. And I tell you that should not that's not a good reason to do that, but the tax impact is important to understand at least so you know what you're getting into. So if you go through this process, you end up purchasing the shares and sell the shares immediately. We know that's gonna be a non-qualified disposition, and so you actually only pay taxes on that discount difference. So from that previous example, you'd be paying $19, uh, not necessarily in taxes, so the $19 was the discount. So $19 per share, you can multiply that out, and then it that gain counts as income there, and it falls into your ordinary income tax bracket, which uh ranges anywhere from 0% to 37%. Uh most of my clients are somewhere between like 22% and and in the 30% range. But that's important to know because that's what you're gonna be paying taxes on, is the discount there. If you do decide to hold it longer and you do start to receive some gains, the gains would also be taxed at the ordinary income tax if you fall under the non-qualified disposition. So where you get that preferential tax treatment is the qualified disposition. So you have to meet those two requirements, but the benefit there, so the discount is always going to be taxed at ordinary income tax. There's no way to get around that or away from that. And again, strategically, you might be able to move that into a tax year where your tax bracket's lower. So you can explore what that could look like potentially, but the discount will always be applied at the ordinary income tax in the year that it's sold. The gains, however, though, if you do meet the qualified disposition requirements, is actually taxed at the capital gains tax rate. So instead of the 0 to 37%, it's 0 to 20%. And a majority of my clients tend to fall in the 15% range. So definitely a dramatic savings in terms of taxes. And again, I just want to remind you that you only pay taxes in the year that you sell the employee stock purchase find shares. And so there's no taxable scenario that occurs prior to that, other than probably miscellaneous, small, not too meaningful dividends on these things as they move forward. The biggest things, the biggest risk uh by far is just missing the enrollment date. It's kind of initially saying, like, oh, I want to do this, it sounds awesome, but then not actually looking into it, not signing up and enrolling because you do have to enroll, and then you get kind of cut off from that enrollment period and you have to wait around if you don't get in. There's also risk too. So I mentioned the potential to lock in guaranteed returns if you sell it instantly. If you don't, then the value definitely can fall after you purchase it. So that's a risk, definitely. You'll want to make sure that you understand that if you do want to hold it more long term, you have to understand that the value could fluctuate. You're probably hoping it's gonna go up, but that's not always the case. Sometimes it may fall in value, uh, which stinks because yeah, obviously you paid a certain amount and it's worth less now. So that's not a good uh thing. There's also the potential to have overexposure to your company. This won't happen usually just from the employee stock purchase fine, even if you're just holding the shares and keep purchasing them. This usually occurs most often, I see, is when you're also receiving non-qualified stock options, incentive stock options, or restricted stock units where you're receiving a huge amount of stock from these other uh benefits. On top of that, you are purchasing employee stock purchase planning a discount, those things can add up, and you can have a lot more exposure than you really realize is comfortable for you. And a lot of times you don't realize it until it's too late. And so it's something to be aware of is make sure that you're monitoring your exposure to your employer, not only from your income standpoint, but also your investment standpoint. Last thing again, and and I mentioned it earlier on as far as one of the reasons why people avoid taking advantage of the employee stock purchase plan, is they just can't figure out how to maneuver their month-to-month cash flow to put so much into the employ stock purchase plan, knowing that they might not be able to access and sell the shares off and access those funds until six months from now or a year from now, if you have those longer time periods. So, first review, make sure you understand, well, is it six months or is it a year? That's a big difference in time frame. But if you are planning to sell it, then you're able to replenish your savings and kind of uh make sure that your plan's moving along that way. If if you receive a big discount, if you if it makes sense for you to actually uh do this, then you definitely do want to just navigate your monthly cash flow and and find a way to make this happen because again, potentially guaranteed returns, and that's that's huge to increase your income by 1% or 1.5%. If you have that look back provision, it could be even greater than that, which is pretty crazy. But have a plan if you want to run a couple of estimates. I have a free calculator on my website, employee stock purchase plan tax calculator, and I'll include that in the show notes. But the cool thing is it will actually calculate on out what that return on investment is, and then it also adjusts for taxes too. So plug in what your tax brackets are, it'll say, hey, this is still your return of investment after you pay taxes too. And so it gives you a lot of uh clear, actionable reasons why you may want to enroll, or if you're already enrolled, maybe take it to that maximum amount allowed so that you can just kind of increase your income without a lot of risk and just yeah, it's just another way to uh increase your financial confidence and take advantage of every opportunity available to you. Hopefully that was helpful. I love the employee stock purchase fund so much. I actually used it early in my career. I was probably 19 or 20 when I enrolled in uh one of the banks that I worked at hit employee stock purchase fund. And it actually was one of the reasons I was able to move out to Colorado and kind of fund my transition to finish school and yeah, move across the country and and and do all those things. So yeah, definitely one of the reasons why I love the Employee Stock Purchase Fund. Thank you for listening to Techie Personal Finance Bootcamp. Remember, if you like what you've been hearing to subscribe, review, and share with your friends and colleagues. I'm also still taking suggestions for future episode topics and guests. If you want to take your connection to the show to the next level, you can find me on LinkedIn or on Facebook. Hit you next time on Techie Personal Finance Bootcamp.