After talking to my coworkers, I learned most of them didn’t join the Employee Stock Purchase Plan (ESPP) offered to us. They said they weren’t sure how it worked and I could see why. It takes time and research to figure it out.
I signed up when I was eligible and I wasn’t even sure how it worked. After the first ESPP period was over, I figured it all out. So here it is:
Should you join the ESPP?
Yes! Absolutely! Everyone should. In essence, it’s free money from your company.
How it works:
After you sign up, a deduction is taken out of every pay check and saved into an account held by the bank (e.g. Fidelity) that manages the plan.
The deduction is after-tax. You set how much you want to contribute (usually anywhere from 1-10% is the norm).
There are 2 ‘Offering Periods’ in the year. Example:
1st period: November – April
2nd period: May – October
So from November – April, you contribute a portion of your check (after-tax dollars) to the ESPP. Your money is saved in your account by the investment bank until the period ends.
Here’s where cool shit happens. When the period ends, the plan will look at the stock price on the first day of the period, and the last day. It will choose the lowest stock price of the two, and then take 15% off.
The bank will buy as many shares at the discounted price with what’s been saved in your account from your contributions.
Example for 1st Offering Period (Nov – Apr)
Nov 2 Stock Price = $77.62
Apr 28 Stock Price = $83.42
Lowest $ of the two = $77.62
Stock Price offered to employee = $65.98 ($77.62 – 15%)
Employee contributions in 1st Offering Period = $780
Stocks Purchased for Employee = 11 shares ($65.98 x 11 = $725.78)
Amount rolled over to next Offering Period = $54.22 ($780 – $725.78)
Here’s how your company is giving you free money:
Now, when you get the stocks, they’re yours to keep or sell. I highly recommend selling the stock as soon as you get it. If you sell the day you get them, you guarantee more than 15% in returns.
Here’s how it can play out (I’m using the same numbers from above):
Stock purchase price = $65.98
Stock sell price = $77.62
Number of shares = 11
Profit = $128.04 [($77.62 x 11) – ($65.98 x 11)]
Return on Investment = 17.64% [($77.62 – $65.98) / $65.98]
17.64% return? That’s way more than what you’re getting in your savings account, and just for 6 months.
Let’s look how your ESPP is affected when the stock price decrease, stays the same, or increases.
|Stock Price Decreases||Stock Price Same||Stock Price Increases|
|Stock Price, Start of Offering Period||$100||$100||$100|
|Stock Price, End of Offering Period||$80||$100||$120|
|Lowest $ of the Two||$80||$100||$100|
|Stock Price offered to employee (-15%)||$68||$85||$85|
|Sell Price for Stock||$80||$100||$120|
|Return on Investment||17.65%||17.65%||41.18%|
As you can see, no matter what the situation is, you always gain when you sell the stock the day you get it.
If you want preferential tax treatment, you have to keep the stock for another 18 months after the period ends. If you decide to sell the stock after 18 months, you’ll get taxed at the capital gains tax rate, which is 15%.
I highly recommend selling the stock the day you get it. The profits you’ve made will get taxed as ordinary income. This is completely fine with me because the interest I get from a savings account gets taxed the same. I’d rather make a solid ROI that the ESPP allows me to, and pay a portion of that to taxes than leaving it somewhere else like a savings account.
If you like free money, then join your company’s ESPP plan!