ESPP shares aren’t the same as your other employer stock — and you should probably handle them differently.
For many of our clients who work in tech, employer equity comes in several different forms. You might get restricted stock, which vests in chunks over time. You might have stock options, which give you the ability to purchase shares at a given “strike price,” or exercise price, in hopes that the actual share value will rise above that level.
Many publicly traded companies also offer something called an Employee Stock Purchase Plan, or ESPP — a benefit that gives employees a way to purchase shares at a discount, using payroll deductions.
And not surprisingly, we get a lot of questions about ESPPs.
What is an Employee Stock Purchase Plan?
There are different structures for Employee Stock Purchase Plans, or ESPPs, but in general, they allow you to set aside money from your paycheck to buy your employer’s stock at a discount over a certain time period.
We commonly see ESPP plans that are offered across six-month periods — employees get a discount (usually 15%) over the stock price at either the beginning or the end of the period.
That means if the stock goes down, you’re still getting a solid 15% discount on the price. But if the stock rises during the period, the discount applies to the beginning price and can be far greater than 15%.
How to handle ESPP stock
We think about ESPPs a bit differently from your other stock comp — as a supplemental income stream rather than as a part of your portfolio. (In fact, we sometimes map them as income in our planning software.)
The idea with ESPPs is that you generally want to capture that discount, lock it in, and not take any further risk.
You should be getting at least a 15% discount — and, as noted, you might get a greater discount if the stock goes up during the ESPP period. So even if you’re giving up about half of it to state and federal taxes, which is what happens when you sell ASAP, that’s a 7.5% return with minimal risk. That’s pretty good by our standards.
If you hang onto the shares longer, they could go up further. Ultimately, if they go up and you hang onto them for a full year, any of the growth beyond the purchase price would be taxable as long term gains, reducing the tax rate.
Trouble is, those shares could go down as well.
‘Participate and liquidate’
You may have heard us refer to this strategy as “participate and liquidate.” We definitely encourage our clients to take advantage of the ESPP opportunity. But we also encourage you to get in and get out as soon as possible to limit your exposure.
For most clients, there’s plenty of other upside available if your employer’s stock continues to rise. Not only do you have plenty of other equity comp, but a successful employer creates other professional opportunities.
But if shares fall after your ESPP purchase, you’ve lost the opportunity to immediately pocket that built-in gain.
In summary, we encourage you to participate in the ESPP program, and then to sell those shares as soon as possible after they land in your account.
And as always, please feel free to reach out to us if you have questions about your own employer’s equity compensation programs.
This information does not constitute legal or tax advice and should not be used as a substitute for the advice of a professional legal or tax advisor. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor. Perigon Wealth Management, LLC (“Perigon”) is a registered investment adviser. More information about the firm can be found it its Form ADV Part 2 which is available upon request by calling (415) 430-4140 or by emailing [email protected].