ESPP - Employee Stock Purchase Plans

 What is an ESPP

Employee Stock Purchase Plans provide the ability to purchase shares using after tax income, often at a discount or predefined price. Each employer can define the rules for pricing the purchase. Purchasing ESPP shares is a great way to have some forced savings, as the purchase cost is deducted directly from a paycheck. The income is hopefully never missed and most of us will adjust our spending accordingly. 

When to sell

The rules and restrictions on sale differ based on the employer. It would not make sense to sell shares that are held for less than 1 year as the gains would be taxed as short term. However, in the event of an emergency it would make sense to tap these reserves and pay the higher tax rate. 

Considerations and risks

Your employer stock may be doing really well, and for good reason. They have a great product or service, however we all experience bias and as an insider are told how great the company is. This may be justified and true. 

Over the years your ESPP allocation may have grown out of proportion, compared to the rest of your portfolio (home, 401k, savings). It may put you at a higher risk should there be an unforeseen event affecting the stock price. 

What if your employee is the next Enron ?

A friend recently shared his experience and the unexpected consequence that I was unaware of. He sold stock in ESPP earlier in 2020. He was under the impression that the stock can be sold at any time. In December, he learnt that there was fine print stating that there is a 2 year holding period. Gains on stock sold prior to this is considered as normal income. 

The rules can be defined by each employer and can differ. Perform your own due diligence, review the links below and make an informed decision, based on your own circumstances. 

Taking action

Once you understand the rules, you can determine the most optimal path. Depending on the restrictions for optimal selling, set a reminder for regular sales of ESPP. Invest the proceeds into a diversified portfolio as a lump sum or over a period of time. 

Reference links

ESPP holding restrictions