Employee Stock Purchase Plans

If you work for a public company, one that has its stock traded on the stock market, you may have access to an Employee Stock Purchase Plan (ESPP). An ESPP typically allows you to buy company stock through payroll deductions, often at a discounted price. If you believe in your employer’s long-term financial performance, an ESPP can be a great way to supplement your investment plan.

Here‘s a closer look at how Employee Stock Purchase Plans work and why doctors may want to participate if an ESPP is available.

What Is an Employee Stock Purchase Plan?

An Employee Stock Purchase Plan is an employer-sponsored benefit that allows employees to purchase company stock automatically through payroll deductions. For example, you could allocate 3% of your paychecks to company stock that’s deposited into an investment account in your name. ESPPs often allow you to buy company stock at a discount. Let’s say you can buy stock in your company at a 15% discount. That’s an instant 15% capital gain every payday.

Employers typically hope that an ESPP will motivate their employees to remain loyal and contribute to long-term profitability. That’s a win-win for the employee, employer, and shareholders.

Want to learn more? Check out this WCI podcast episode about stock purchase plans.

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How Do Employee Stock Purchase Plans Work?

When an ESPP is available, you can usually sign up while completing your new employee information paperwork or during open enrollment. Depending on the plan, you may be able to sign up, cancel, or adjust your contributions at any time. Check with your HR department or ESPP documentation to find out how to join and adjust your contributions.

Limits

In most cases, an ESPP will come with contribution limits. That could be measured as a percentage of your paycheck, a total dollar amount, a number of shares, or in other ways.

As a doctor with a high salary, you may come up against contribution limits. If you can manage your ESPP participation online, the website should automatically prevent you from contributing over the limit.

Eligibility

Not all companies with ESPPs allow all employees to participate in the plan. They may be limited to those who work a minimum schedule or who have been with the company for a minimum number of months.

Again, consult with your HR department or plan documentation to learn more about eligibility and participation requirements. If you work 35 hours per week for the employer and need to work 40 to join the ESPP, those five extra hours could be well worth the effort.

What Are the Benefits of Employee Stock Purchase Plans?

As an employee, an ESPP has several significant financial benefits. Here are some of the most important Employee Stock Purchase Plan perks to consider:

• Grow your investment portfolio: To start, an ESPP is a good way to build your investment portfolio. Assuming you’re already taking advantage of your 401(k) and/or maximizing your IRA contributions, an ESPP can help you build a taxable investment portfolio, which you can sell before reaching the age mandated for tax-advantaged accounts.
• Instant capital gains: If you can buy at a discount, you get an instant capital gain every payday. For example, if you can buy stock at a 10% discount and contribute $1,000 every payday, your stock is instantly worth $1,100 when the stock posts to your accounts. Even if the stock goes down by 10%, you’re still breaking even. And if the stock goes up, you’re earning more than 10%.
• Profit when your employer profits: With an ESPP, you’re tying a portion of your wealth to your employer’s success. If you believe the company will continue to grow and profit, you can share in the financial benefits. Whether that’s through dividends, stock appreciation, or a combination, it’ll put more money in your accounts.

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What Are the Disadvantages of an Employee Stock Purchase Plan?

While we’re generally positive about ESPPs, they’re not perfect for everyone, and there are risks involved.

• Stock may underperform: The biggest downside of an ESPP is a risk inherent in all investments: the stock may underperform. If the stock goes down or lags behind the markets, you could wind up in a worse financial position than you would have been had you skipped ESPP contributions.
• Concentration risk: Another risk happens if you accumulate a disproportionate percentage of your portfolio in company stock. As we saw with employees who heavily invested in Enron, investments in your company may turn out to be a total loss. If too much of your portfolio is in company stock, it can have a serious negative impact on your finances.
• Tax implications: Taxes for ESPPs can be complicated. There are qualified and disqualified sales, which depend on how long you held the stock. It’s essential to keep records of all purchases for future sales. Discounts may be taxed as regular income. The list keeps going. Due to these complications, it’s vital to maintain accurate records and proceed with caution.

How Are Employee Stock Purchase Plans Taxed?

Speaking of taxes, here’s a more detailed look at the tax implications of ESPPs:

• Taxes at purchase: You usually don’t owe any taxes when you buy shares through a qualified ESPP, even if you got a discount. This effectively allows you to defer taxes on that portion of your income.
• Taxes at sale: You’ll pay taxes when you sell your ESPP shares, which may include a combination of income and capital gains taxes.
• Qualifying vs. disqualifying sale: If you hold your shares long enough (at least one year after purchase and two years after the offering), you may qualify for more favorable tax treatment.
• Disqualifying sale taxes: Selling too soon means a portion of your profit is taxed as regular income, not just capital gains. For most people, that’s a higher tax rate.
• Qualifying sale taxes: If you meet the holding period, most of your profit is taxed at long-term capital gains rates, which are usually lower.
  
• Watch for ordinary income: Even in a qualifying sale, the discount you received may be taxed as ordinary income.
• Tax reporting: You’ll get tax forms like a 1099-B when you sell shares and possibly a W-2 if there’s ordinary income to report.
• Set aside for taxes: Your employer may not withhold taxes on ESPP sales, so you may owe money at tax time.

More information here:

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What Happens if You Change Jobs?

ESPP investments are typically not subject to vesting periods, unlike those commonly found in 401(k) plans and stock options. If you change jobs, you’ll usually get to keep your stock in the existing account or get to transfer your shares to your preferred brokerage.

You can hold onto the stock well into the future if you’d like, or you can sell if that’s your preference. While you can't buy more stock in the company at a discount, you can keep everything you bought through the plan while you had the job.

The Bottom Line: Are Employee Stock Purchase Plans Worth It?

If you believe your employer’s stock will hold its value or grow in the future, ESPPs are worthwhile investments. They’re easy to join, and your investments are made with the same automated set-it-and-forget-it method as your employer’s tax-advantaged retirement plan. And the instant capital gains you get through a discounted purchase can supercharge your profits.

But if you don’t believe the company has good financial prospects, you may want to skip contributing. At the end of the day, company stock is just like any other. But in this case, at least, you have more knowledge about your company than the average investor. That puts you in the best position to decide whether it makes sense to add it to your portfolio.

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