ESPP – While the acronym and the spelled-out version – employee stock purchase plan – don’t sound particularly exciting, the financial rewards can be. That’s because, under most circumstances, people whose employers (publicly-traded companies) offer an ESPP can profit by using this benefit strategically.

Through an ESPP, you can purchase company stock at a discount via payroll and sell it later at full price. The devil, as always, is in the details, but while each employer’s plan has its differences, there are ways to take advantage of this benefit without taking a lot of risk.

At Modera we consider investment diversification, meaning having a wide range of different kinds of assets, to be the crown jewel in a thoughtfully constructed portfolio. When you own portions of thousands of different companies (via your stock exposure) and lend to different companies and to the US government for varying amounts of time (via your bonds), you reduce your chances that any one company’s poor performance will hurt you and your ability to achieve your goals.

If you work at a publicly traded company, your future is impacted by how the company’s stock performs (via the calculation of your bonus), and your financial security is influenced by how your company performs relative to peers and how it weathers challenges. Purchasing stock in your employer can seem unwise since it creates even more of a link between your and the company’s financial success. However, an ESPP allows you to benefit without the need to take significant risk

How does an ESPP work?

A qualified ESPP allows an employee to apply up to $25k of their income annually to purchase stock in their employer at a discount, typically 15%. Funds are taken from payroll and used to purchase stock during a set period. The price is discounted, and often your stock purchase price is whatever is lowest: the beginning- or end-of-period price.

Scenario 1: Up 20% Scenario 2: Flat Scenario 3: Down
Purchase price $100 $100 $100
Discounted (15%) price $85 $85 $85
Sale Price $120 $100 $80
Pre-tax Gain/Loss $120-$85 = $35 $100-$85 = $15 $80-$85 = ($5)

Who can participate in an ESPP?

If you have access to an ESPP, this benefit should be part of your benefits brochure, and accessible either via your workplace online portal, or by contacting your HR department. Only publicly traded companies offer ESPPs. The US Securities and Exchange offers a search tool through which you can see whether your company indeed offers one.

How long should I keep the ESPP shares, and how are they taxed?

When you sell your ESPP shares after their lock-up period (typically between one week and six months), the difference in the discounted purchase price and the sale price will be taxed as ordinary income (same as with your paycheck). Selling the shares as soon as you’re able to limits the risk and is the safest way to utilize the ESPP. However, any significant decline in the value of your company’s shares can create losses, so even this strategy is not without risk.

If you hold on to the shares for more than a year after the date of purchase AND for more than two years after the offering period starts (effectively, if the shares are held for more than two years), the gains in excess of the purchase price discount will be taxed at long-term capital gains rates, which are lower than ordinary income rates.

However, a disciplined strategy of selling your ESPP shares as soon as possible, capturing a benefit due to the discounted purchase price, while limiting exposure to the fluctuations of your company’s stock, is a prudent strategy for most investors.

Modera advisers are adept at helping employees with stock options implement the strategies that may be the most advantageous for them. To learn more about how Modera can support your financial goals, contact us.

Modera Wealth Management., LLC is an SEC registered investment adviser with places of business in Massachusetts, New Jersey, Georgia, North Carolina and Florida. SEC registration does not imply any level of skill or training. Modera may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements.

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This article is limited to the dissemination of general information about Modera’s investment advisory and financial planning services that is not suitable for everyone. Nothing herein should be interpreted or construed as investment advice nor as legal, tax or accounting advice nor as personalized financial planning, tax planning or wealth management advice. For legal, tax and accounting-related matters, we recommend you seek the advice of a qualified attorney or accountant. This article is not a substitute for personalized investment or financial planning from Modera. There is no guarantee that the views and opinions expressed herein will come to pass, and the information herein should not be considered a solicitation to engage in a particular investment or financial planning strategy. The statements and opinions expressed in this article are subject to change without notice based on changes in the law and other conditions.

Investing in the markets involves gains and losses and may not be suitable for all investors. Information herein is subject to change without notice and should not be considered a solicitation to buy or sell any security or to engage in a particular investment or financial planning strategy. Individual client asset allocations and investment strategies differ based on varying degrees of diversification and other factors. Diversification does not guarantee a profit or guarantee against a loss.