The last time I checked my stock portfolio, I noticed I had 8 shares of IBM and 1 share of Kyndrl (which, apparently, is a recent spinoff of IBM). I didn’t recollect buying any IBM stock (let alone Kyndrl!), but it turns out I obtained those shares through an employee stock purchase program when I worked for IBM from 2006-2008.
Since then, I haven’t participated in the ESPPs (Employee Stock Purchase Programs) offered by my various employers. They seemed like too much hassle for the benefit. And, I generally feel like I have enough exposure to the companies I work for, so increasing that risk can feel ill advised (geriatric millennials like me will remember people losing their life savings in the Lehman Brothers or Enron collapses).
But, having recently switched jobs, I took another look at the ESPP, and learned that:
- Not all ESPP programs are created equal
- There are some hidden benefits that make ESPP programs more appealing than they seem at first glance.
First — the basics. ESPP programs are a company benefit that allow employees to purchase shares of the company, generally at a discount. Typically your company will deduct money from your paycheck over several months (the “purchase period”), and then buy the discounted stock on your behalf at the end of that period. Most plans fall within the IRS rules for a “qualified plan” (more on that later) meaning that the maximum annual purchase is $25,000.
But, from that common baseline, there are a wide array of factors to consider.
A) Stock Discount Level — Some companies, like my former employer Oracle, provide just a 5% discount. Other employers like Salesforce and Adobe provide a 15% discount. That’s a big spread.
B) How That Discount is Applied — Some companies simply apply the discount to the price at the end of the “purchase period”, so your maximum discount is against the price on the day the stock is purchased. Back to the Oracle example, they applied the 5% discount to the price on the day that the stock was purchased. So, if you started contributing money on Jan 1 and the stock is purchased 6 months later on July 1, the discount is applied to the price on July 1.
But other companies, like Adobe and Salesforce, apply the discount to the lesser of the price at the beginning or end of the purchase period. This is typically called a “look back” provision.
So, if you started contributing money on Jan 1 when the stock price was $10 and the stock is purchased on July 1, when the stock is $15, you’ll get 15% off of $10 (8.50). That’s an effective 43% discount when the stock is purchased! A lot more appealing than the 5% or even 15% on the “face” of the plans.
C) Ability to “Reset” — If the stock does nothing but go up, then the lookback provision has you covered.
But, what if the stock goes down (which, based on what’s happening in cloud software right now, could certainly happen)? This is where the “reset” provision kicks in.
If the stock is priced lower at the end of the purchase period than at the beginning, you not only get to take the discount from that lower price in period 1, but also for a designated amount of time after.
Adobe appears to have the best policy here. Their reset applies for 24 months. So if the price is $10 on Jan 1 and the $8 on July 1, not only do you apply the 15% discount to the $8 price on July 1, you also lock in 85% of $8 ($6.80) for the next 24 months!!
D) Tax Benefits – This applies to most plans, but is a nice perk. If you keep the stock for 2 years from the start of the purchase period (in the above examples Jan 1), you will pay long term capital gains (generally max of 20%) on the discount you received (as opposed to the much higher ordinary income tax rate you’d pay if you sold the stock immediately). Doing so is called a “qualified” disposition, and is allowed if the plan follows basic IRS rules (like the $25k maximum).
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Like I said, not all ESPPs are created equal. But, the best of the bunch provide a bevy of attractive features from look backs to resets that can net you a pretty penny. If you max out (assuming a 15% discount), and sell right away, you can earn an extra $3,750 per year in a relatively pain free way (though you’ll have to pay taxes on this at the higher tax rates). This isn’t even accounting for the ability to take advantage of a significant “lookback”.
But, if you’re not scared off by increasing your financial reliance on your company’s performance, you could also hold. Equityftw reports that an Adobe employee could have earned $343,000 in the 5 year period ending 12/31/20 by maxing out their ESPP. That’s a lot of coin.
Happy ESPP-ing!
Disclaimer: I’m not a financial advisor nor a tax attorney. Read up and get some professional advice!