Monday, March 9, 2015

You Down with ESPP?

First world problem alert: we have an investment decision to make, and one with tax consequences, too. (Remember back when we used to have to choose between paying rent on time or paying our credit card bills before the late fee kicked in? Those were the days. It's like Kevin Spacey said back in American Beauty. All I did was party and get laid. )

So, my employer generously allows us worker bees to participate in an employee stock purchase plan. Basically, it allows employees to pay into a program, and to buy the company stock at a discount.

Here are the details:
  • Employees can put up to 10% of their income each paycheck into the plan, for a six month period.
  • That money sits in a cash position for those six months, then buys the company stock on a specific day.
  • Here's the fun part. The purchase price is X% less than the lower of the two dates: the first day of the six month purchase period, or the last day of the six month purchase period
  • So, that means if the stock went up over those six months, we get to buy it for X% less than whatever that price was six months ago. That means we'd get more than an X% discount (the price delta from today's date to the purchase price six months ago...minus X percent)...which is great.
  • If the stock goes down over those six months, then employees just get X% off.
  • Any time after the purchase, we have the option to sell the stock, or keep it. 
So, all in all, it's a cool program.

The problem is that I don't like holding any single stock, let alone that of the company that also is responsible for providing me a paycheck. It seems risky to concentrate your wealth and income source in the same company. Besides, I'm a straight up Boglehead and index all the way...until now.

The rub is that if we sell right now, all the gains get treated as short term capital gains: i.e. - taxed like regular income...which sucks. (I can hear those Syrian children getting ready to bludgeon me for complaining again.) If we hold on to the money for another 18 months, the gains get (mostly) treated as long term capital gains, taxed at a nice low 15% rate.

And if we hold on to the stock all the way until early retirement, we might be able to sell it while we're in the ultra-desirable 15% marginal tax bracket, meaning we'd pay 0% tax on the gains. (I call this the GoCurryCracker Special...TM). Of course, early retirement is still at least six years out. And if we keep on putting 10% of every paycheck into this stock, and we keep getting discounts on each purchase, we could have way, way too much of it in our portfolio by the time early retirement comes around.

So, what's a boy to do? I figure we have four pretty good options.
  1. Sell the stock immediately after each purchase (i.e. - every six months), pay the higher short term capital gains, and put the funds into our asset allocation (A.A.): Bernstein's Simpleton's Portfolio
  2. Wait the requisite 18 months, sell the oldest batch of stock at the lower long-term capital gains rate, put funds into A.A., and repeat each six months.
  3. Pick a percentage of our total portfolio we are comfortable being in this single stock (e.g. - 5% of all our investments) and sell whenever we go over that amount, regardless of tax consequences.
  4. Hold on to stock until our income drops (early retirement or job loss), try to pay 0% on all gains...and ignore the ever growing slice of our portfolio the stock represents.
The rub is that I can see the merits of each approach. Staying within our asset allocation seems prudent, so maybe selling immediately is wise...if a little risk averse. Waiting will save us on taxes, and perhaps would make us more money. But the longer we wait to sell, the more of our investments will reside in that single stock.

As we usually try to do when we have a tough decision, we turn to our brain trust: our readers. Of course, you are wasting part of your Monday reading this sorry blog...so how smart can you be? Regardless, I'd still love to hear what you'd do in this situation.

I realize you don't have all the information (how much we make/what tax bracket we're in, what the company stock is, what the discount is, etc.) As we value and try to preserve our anonymity, I can't share a lot of the details of our financial lives any more. Sorry 'bout it.

Instead, I'd like to hear what you would do with this sort of Employee Stock Purchase Plan. If you were in our shoes, what would you do? Apply your own situation, investing style, income, and tax strategy, and please pick one of the options below. I'm excited to see the results...and not just because I finally figured out how to insert a poll into a blog post.


Just to be safe, I should probably remind myself and everyone else that I am not offering investment or tax advice, or advice of any kind. Before making investment decisions, you should seek the advice of a professional, along with that of your shaman and your mother.

I, on the other hand, am willing to foolishly take the advice of internet strangers. Opinions are welcome, as is candy.


*Photo is from puuikibeach, used under the Creative Commons License at Flickr.

39 comments:

  1. I had to decide whether to enroll in my new employer's ESPP program recently. I can also sell the stock right away and that's my plan. That's what I've always done with any employer stock I've gotten in the past, so I'm sticking to that plan. If you sell the stock reasonably soon after it's bought, your short-term gains should be fairly minimal at least. Your third option isn't bad either, but I wouldn't wait for long-term tax rates to kick in or for early retirement.

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    1. Hey Leigh! That was my initial thought. I am wondering now if that's a bit too risk averse, or if it's simply good sense to take the gains, pay the higher taxes, and stay in your AA.

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  2. I also have an ESPP through my employer. I typically try to sell the shares once they hit my account or start selling covered calls on them if I own more than 100 shares. Option 3 is a good idea as well and something I might have to consider with my own ESPP.

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    1. So that's two comments for the sell immediately option (oddly, only one vote out of 14 so far though).

      I love option 3 as it's a middle ground and puts a line in the sand re: how much stock I'm comfortable holding. Though each option does seem to take the day to day decision making out of the equation.

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  3. I like the Go Curry Cracker Special. It's a popular item amongst the ER thugs

    My employer had a similar plan, although somewhere along the way they eliminated the 10% of the lowest of the start or end price, and it was just 10% off the end price.

    90% of the time, I sold immediately and paid tax at the marginal rate. I just asked myself the question, if taxes weren't involved would I hold this stock? Since the answer was no, I sold. If the answer is yes, then hold for 18 months but not more than your target allocation

    There is one piece of information missing to make a fully informed decision, and that is your marginal rate. If you were paying 39.6% on the gain it might be more interesting to wait than if you were paying 15% or 25%

    Another way to look at it (assuming 25% marginal rate): 25% of 10% of your income is only 2.5%. If your employer asked you to change your asset allocation in exchange for a 2.5% raise, would you do it?

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    1. Decimal is in the wrong place, but you get the point (haha)

      25% tax on 10% gain on 10% of income = 0.25%

      Delete
    2. That's a very cool question to ask: how much of a raise would I take to change/violate my AA.

      However, as your second comment noted, we're talking about very minimal benefits compared to my overall salary. It's kind of a weak 'raise' they are offering, to change my AA: a fraction of one percent.

      You may have just won the debate, and three comments in. Another strong vote for selling immediately.

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  4. I'm thinking about some kind of way to set up a hedging system. Sell a certain % up front, hang onto some other % the requisite 18 months, and some other % hold until early retirement. It's complicated, but it might be your best way to make sure you're taking all avenues. If that's not possible, I'm all for selling at 15% after the 18 month period. Thanks for the brain exercise on a Monday! Cheers.

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    1. Taking multiple paths is certainly a way to make sure I get a piece of the optimal approach. But with new stock being added every six months, things could get very complicated over the course of years. What seems manageable now could be a mess in 2020.

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  5. My company has an ESPP that I participate. I can purchase up to 7.5% of my salary. Every month my company (computershare) buys stock for the amount I contributed. After a 3 (THREE) YEAR holding period, my company will match my stock one for one. The matching stocks will be considered income and social security, medicare, and income tax will be taken separately from my paycheck.
    Right now I elected to contribute the minimum amount. While the matching shares are good, I'm afraid of holding such a large portion of my investments on one stock. Especially since that one stock holds my salary too. As soon as the 3 year holding period is up on some of the share, I will start selling the shares that I have had for over a year, then I will consider selling the newly matched shares based on tax gain.

    I do not plan on holding my shares for the long term (more than the 3 years). I have met so many people at my company that got burned by fully investing in their company's. They lost so much money when the DOT Com bust hit or when the company went under.

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    1. For a 100% return, I definitely think it's worth the three year wait. That's a crazy good benefit. (Of course, the entire match being treated as income lets the government take a bite.)

      Our plan is structured differently, so we technically only need to own the stock for one day. It seems most of the commenters are leaning towards selling after that day, though hardly any of the votes in the poll point to that option. Curious.

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  6. Just a heads up on something you might want to check on. Mr PoP participated in an ESPP at his previous employer (his current ESPP isn't worth it), and there was a weird stipulation that he didn't know about until it was too late... Because he got it at such a discount to the actual price, there was a time window of several years (I think 3) that he would have needed to hold it to avoid paying INCOME TAXES (not capital gains) on the match/discount pricing. We didn't know this and sold it about 6 months too early when we really needed the money to replace our siding right after we got married and bought our house. Got a letter from the IRS a few months after filing our taxes where they kindly asked us to pay income taxes on that amount. It wasn't a huge deal since it was a small amount of stock (maybe $3K worth?) but if you're planning on doing this and regularly selling every 12 months to avoid capital gains, make sure you don't need to pay extra income taxes too!!!

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    1. That is a fantastic point and yes, our ESPP has the same wrinkle on the discount: the X% is always earned income, regardless of when we sell.

      I don't know if this makes a better argument to sell immediately, or to wait all the way to E.R. :/

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    2. https://blog.wealthfront.com/manage-vested-rsus/

      "If your company gave you a year-end bonus of $100,000, would you use all of it to buy your company’s stock?

      Hell, no."

      While this is talking about restricted stock, the same applies for ESPP. Take the money and run!

      Delete
  7. I won't tell you what I would do, but instead what I used to do when I worked for a public company that offered a similar deal. We could allocate up to 15% of our income and we would get stock every 6 months at the lower of the 1 or last day of the trading window less an additional 15% (just as you explained in your post).

    My philosophy was that you don't look a gift horse in the mouth. I always sold immediately after each distribution occurred. It was almost a guaranteed 15% return depending on how the stock performed between the last day of the trading period and when the shares were distributed. And much more when the stock trended higher from the start of the 6-month window.

    I contemplated the tax issue for about 5-seconds. Then I just told people that taxes were a good problem to have. My first distribution made me almost 300% on my money before taxes. Then my 2nd distribution was something like 180%. My 3rd and final distribution before I moved companies was about 70%.

    It has worked our really well. My last sell was at a share price of $8.54/share, today after being gone from the company for almost a year, the share price is under $2.

    I would had regretted losing a guaranteed profit just because I wanted to avoid taxes.

    Cheers!

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    1. That's an excellent perspective on capital gains taxes. No one ever went broke taking a profit.

      While the 'sell right away' camp is not winning the poll, it seems to be a very popular answer in the comments.

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  8. If I really believed in the company, I'd probably hang on to the stock until a later date, but I think the best course of action is selling immediately. It sounds like you have your own really clear investment plan, and sticking with that along with the comfort it gives you is really worth a lot, and certainly worth the expense of paying a little tax in my humble opinion. I think you'll just create too much angst in one form or another, and much more risk than you want, for possibly not much greater financial benefit.

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    1. Sheesh, even those bloggers with the stones to invest in single stocks are telling me to sell. :)

      My plan is definitely to index all the way, so the stock would be an aberration.

      I just hate taxes.

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  9. #1. Buy, sell as soon as you can and pocket what you will after taxes. It's like "free" money, and the taxes shouldn't drive your decision. I've got some posts coming up on restricted stock, which is the boat I am in. And my recommendation, sell the day you can and don't look back. There's a great article somewhere with the guy saying whatever social phenomenon keeps you staying in the game. I'll try to look it up later.

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    1. Thanks, Elroy.

      Yet another vote to sell immediately from another ER blogger I respect.

      Delete
  10. The first question I would ask myself is if I would buy this stock if I was not getting a discount. If I would then I would have no problems holding the stock until retirement, if not then I would sell and put the money into index funds afterwards.

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    1. That's the key question, and the answer is 'no'. I would not hold any single stock. That's no judgment on my company's stock...just my investing style.

      I think we have our answer.

      Delete
  11. I'm with others in that I'd sell immediately - I'm lucky in that I've never had to make that choice though. Don't let the tax tail wag your profit dog - make the best choice not considering taxes and then worry about how you're going to file :)

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    1. Thanks, Three is Plenty. We ended up selling...and then the stock promptly went up 2%+ the next day. :)

      Oh well, you never go broke taking a profit.

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  12. I never thought about owning stock and taking your paycheck from the same company as risky before, but now that you mention it, it probably is a more of a risk than I thought. I'm not very pro-risk, so I'd probably avoid investing too much into the program.

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    1. Thanks, Kayla. That was the kicker for us. We hate single stock, but especially hate having it with the same company paying us.

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  13. I would just continue to stick to your plan. I know you hate stocks, but so far this is working for you. Sell the stock after six months. Index those monies and just keep plugging away.

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    1. Thanks, Jason. That's what we did and are on track to keep it simple, and keep buying/selling every 6 months. We'll own the stock about 2 days out of the year. :)

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  14. If the stock paid me a dividend to hold it, I'd wait the 18 months to grab the long term cap gains rate. If not, I'd sell it as soon as it hit and consider it extra salaried income in a mildly annoying non-passive form.

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    1. That is definitely a tempting alternative, and probably the smartest tax-wise. But we don't have the appetite to change our AA just to avoid taxes.

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  15. This is an absolute NO BRAINER. I had a similar option at my employer a while ago.

    It may depend on how long you have to hold it. I could sell mine immediately.

    You get a guaranteed x% return in 6 months. That is a 2x return annually. But you only have on average half the money invested for the 6 months. That's a 4x return annually.

    $100 a month, for 6 months, is only $300 on average invested over the past 6 months.

    Whether you sell or keep it is an entirely different decision. I would sell most and S&P it.

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    1. Yeah, the annualized returns are crazy good, especially if the stock goes up. If it goes down, we get a guaranteed 15% in just a six month period.

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  16. I think I'll hold on to it to avoid most of the taxes. I just hate those taxes!

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    1. Me too, but then I remember that paying taxes on a gain is not such a bad thing.

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  17. I had the same exact offering as the original post soon after my company went public a year ago. I chose to immediately sell my shares and take my profit. One thing to be aware of is there are typically no taxes withheld so make sure to plan for that amount when you file at year end. I chose this route because I treated my ESPP as the replacement for one of my savings accounts and I figure heck, who wouldn't take a minimum of around a 17.5% 6 month return on that!

    Since it is originally your cash being spent you also aren't risking your original investment. As other's state you have a choice along with the risk of an increasing or decreasing price only to realize what is in my mind a smallish tax break.

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  18. I went back and forth on this as well, but me in the "wait 18 months camp then sell FIFO" amp, AS LONG AS YOUR COMPANY STOCK IS REASONABLY STABLE.

    My company's stock is pretty much flatlined for years (relatively speaking) so the only thing I really fear is a 2008 like recession crash. Even then, 18 months of my company's stock is not going to break me if it tanks, so I'll just hold it and wait for the eventual rebound.

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    1. Sorry for typos. Will do better next time :-)

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  19. What did you end up doing?

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    1. We are selling immediately, taking a tax hit, and investing in our asset allocation. Basically, just sticking our investing plan.

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