ESPP w/ holding period strategy

[Buddy_Z]

Hello, I've searched your forums and have found some helpful information regarding ESPPs but it seems most of the discussions were centered around selling immediately. Unfortunately, my company has a 6 month holding period from the date of purchase and I'm a bit lost on how I should be using this program.

Quick background. My wife and I both work at the same company with a combined income of about 125k/yr. Both mid-20's and have a relatively small amount of student debt. I feel we're fairly risk tolerant but that's probably something all 25 year olds think.

We both invest 8% into our 401k's which is the minimum to get the full 6% company match. We both recently joined the ESPP which allows up to 10% of your salary and makes purchases on a quarterly basis. We both fund 10% at the moment, but I'm quickly getting the feeling we're soon going to be way too heavily invested in our own company.

I guess my question is what type of strategies are available to me in an ESPP with a 6 month required holding?

Thanks in advance!

[rodi]

When my employer had an ESPP, I was in the churn and burn camp - sell the first day I could to lock in the discount (and sometimes the gain from the previous 6 months.) We were able to sell about 5 days after the stock was purchased. Which was paid for by contributions from the previous 6 months of salary deductions.

I think my inclination to sell at first opportunity would still apply if I'd had to hold it past that 5 day book-keeping wait. I'd sell as soon as I could.

I had many friends who held the stock - and in some cases lost not just the discount, but some of their principal (what they'd had withheld from their paychecks.

I miss the program - it went away when my megacorp was acquired by a bigger megamegacorp last year. It was a really nice 15% return on 10% of my salary, twice a year.

[FIREd]

I used to participate in my employer's ESPP. I only participated when I could ensure that I would be buying the stock at a good price - the stock had to be cheap at the beginning of the 6-month subscription period. Then I held the stock for at least 18 months IIRC for maximum tax benefit (qualifying disposition).

[Animorph]

Buddy, your ESPP sounds different than the three I've had experience with. I think the most common form is a six month period, with a discount of 15% off the lower of the starting or ending price. It's a relatively easy 15% when you sell immediately, especially if there is an option to automatically sell at the end price. But periods and discounts vary.

If you have a one-quarter purchasing period with an additional 6 month wait before you can sell then you are taking on quite a bit of risk. I'd say if you like your company stock and can see yourself participating for many periods, then you'll probably average out with an overall gain. Or, as mentioned by FIREd, only participate when the stock price is lower than usual.

I also held on to some shares to get long-term capital gains treatment when the discount was particularly good. I did OK with that, but not always.

Be careful to understand the rules for qualifying and disqualifying dispositions. Sometimes it will be better to sell early, sometimes late.

[RunningBum]

I wouldn't say it is quite a bit of risk, especially if you get the lower of the start or end of the purchasing period. Unless the company stock is really volatile, you are getting a nice discount, and it could move up in those 6 months as well as down. Even if you hold it long enough to get LTCG benefits, you probably aren't holding THAT much company stock at any time. If you're really uneasy about the company, one of you might want to focus on finding a job at a more stable company. Otherwise, just don't invest anything else like any part of your 401K in the company stock. Initially you will be heavy in the company, but after a couple sells and hopefully re-investing in something like a broad index, you'll be much better diversified.

Sounds like you are doing great at 25.

[clifp]

I am with RunningBum.

Most ESSP program with 15% discount on the lower or higher period of 6 months or even quarterly at the have internal rate of returns over 50%. I think they are almost always great deals and you are smart for taking advantage of them.

In order to take advantage of the long term capital gain rate on both the 15% discount and any subsequent price appreciation you have to hold the stock for at least 1 year from when you acquired it and two years from the grant period.

Although many advocate selling it as soon as possible. I suggest a different strategy.
If at the end of the lock up period the stock has appreciated it I suggest holding until you it is a long term capital gain and then selling the stock. If on other hand the stock has only a small gain or a loss than I'd suggest selling it as soon as possible.

While there is some understandable concern about being overly concentrated in company stock, I don't think it is that big a deal. Assuming your income is ~1/2 of the 125K figure the worse case is you'll be holding stock equal to 20% of your salary with some discount appreciation etc. So roughly $15K-20,000, even if the stock drops by 1/3 this will be painful but hardly life changing. On the other hand the benefits of only paying the 15% long term capital gain + state long term gains rate vs the ordinary income rate of 28%+state can add up to many tens of thousand of dollars if you have a 10+ year career.

[Buddy_Z]

Thanks for the input. I wasn't aware there was much variability between ESPPs. Mine does give the discount on the lower of the two dates.

The company stock is not volatile and overall we really like the company, though it is in the same sector as Enron...

Looks like I should spend some time getting a little more familiar with the specifics of my program and make sure I fully understand all tax implications (duh) of when I choose to sell.

What I initially considered was once we hit our first selling opportunity, and can then sell every three months, was conservatively estimate the net gains from selling and increase our 401k contributions proportionately. In my head it seems like a free 1-2% increase into a tax deferred account, but that of course doesn't factor in the cost of 6 months of that extra income being tied up and I could also be terribly inaccurate with my estimate.

I guess some due dilligence is in order and then I'll just have to implement a plan and adjust as it plays out.

Thanks for the input, up until yesterday I was content with just letting it sit forever. Didn't realize I had so many good options!

[MichaelB]

The tax cost is pretty straightforward, and you will need to keep good records. The difference between the purchase price and market price on day of purchase is ordinary income no matter how long you hold it. The change in market price is taxed as capital gain. Your plan may have provisions, so it helps to check. Investing the max makes sense if you are getting a 15% discount, you can then pursue one of the strategies already described. Buying, then selling ESPP stock is not a bad way to fund a ROTH.

[Buddy_Z]

Excuse the ignorance, but being that this is an early retirement forum, why would I necessarily want to fund something like a ROTH that I can't touch until 59? If I'd like to retire at, say 48-55, shouldn't I start building an account that I can use in the years before I can withdraw penalty free from my retirement accounts?

[bUU]

I think the challenge of ER is making sure you have the resources you need all along the way. So it makes sense that some of what you do will be to address your needs while you're in your 50's, but also some of what you'll do will be to address your needs in your 60's, and 70's, etc.

[RunningBum]

Ideally you'd fund both retirement and non-retirement accounts. Following the ER years is the years after 59 that you still have to provide for. One plan might be to fund enough non-retirement to make it from 48 to 59, then live on Roth/IRA/401K from 59 to 70 and then supplement that with social security and perhaps a pension and/or an annuity after age 70. This forum is for more than just funding the ER years. Even if a Roth IRA wasn't a retirement tool we still talk about finances in general, but a Roth can be a key part of ER.

A Roth also allows for tax and penalty-free withdrawals of the original contributions before age 59. See Tax-Free Distributions from Roth IRAs . The Fairmark site is a good place to explore Roths in general. You can also withdraw from a 401K early under a 72t plan without penalty.

A Roth IRA is a powerful investment tool and it seems to me that most anyone eligible to contribute to one. There are a few exceptions, such as if you are simply struggling to meet basic needs with your income, and obviously high income people aren't eligible. A few are concerned the tax laws might change and it might later get taxed.

[JoeWras]

Good advice above. Diversify, diversify, diversify. This includes the *types* of retirement and investment accounts. Roth should be part of that.

As for ESPP. Well, my strategy used to be to have a "conveyer belt" of lots. Every 6 months, our plan bought a lot. I would hold it until it went to "qualifying" status. So, when I'd buy, I'd also sell in a FIFO fashion the oldest that just qualified. There were always lots on the conveyer waiting to be sold. Never let it go beyond that. So, IF you MUST hold onto your stock, I recommend this approach. Sell the lots when they qualify with the IRS for better tax treatment.

However, sadly, this did not work well for me at the two companies I was at. One suffered greatly from the late 80s to the mid 90s with constant falling prices. I lost real money on that ESPP. The other is a tech company. It has had flat prices since the tech bubble crash of early 2000s. Waiting for qualifying resulted in some gains, and some losses. And when I say loss, I mean BELOW the 15% discount. Ouch.

I have since discarded that method and now sell the minute it shows up in my account. Years of experience have convinced me this is best. I have so much risk in my company by just working there, why tie it up in stock, even if it is only held for a year or so?

I take my minimum 15% and run. Run, Run. D*mn the extra tax hit. I then invest it in something diversified.

That's my recommendation to any newbies. It has been a learning experience. Yep, seems like you are not supporting your company. So what. They'll lay you off and not support you when times go bad. Don't worry about it.

[smjsl]

Hi Buddy_Z, I can relate - years ago I used to follow the same path as you with similar questions... What I learned was that tax-free accounts like Roth as tax-deferred accounts like 401(k) are extremely valuable tax-advantaged "spaces" for your stash as they help you control how much money you can get out and at which tax rates, and because they don't have a tax drag while the money is growing in them. After 401k match, it's very highly advisable to max out your Roth. Then, I would suggest maxing our your 401k too if you can, and then save more in taxable account if you still can. (As others posts mentioned, you can get (principal) money penalty free from Roths and there are rules (you can google "rule 72t"), to get some from 401k/ traditional IRAs too prior to age 59, but you will also want to have money in these accounts for post-age-59 as well, even if you first spend taxable accounts savings earlier.)

Unfortunately, I can't catch up for my lost years of just contributing little to 401(k) - just for employer match. Now, I end up with way too much savings in taxable accounts with the tax drag and almost no space in tax-advantaged accounts. Maybe you can learn from my mistake ;-)