ESPP Strategy & Advice

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jmangi5
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Joined: Thu Dec 05, 2013 2:48 pm

ESPP Strategy & Advice

Post by jmangi5 » Fri Mar 17, 2017 12:47 pm

Hello fellow Bogleheads! I'm a longtime lurker, and first time poster. I've learned quite a bit from this forum after reading a number of member posts, and I'm hoping I can obtain some community advice. My question is regarding ESPP strategy.

My company allows its employees to purchase common stock shares via payroll deduction or lump sum contribution at a 15% discount. There are 2 semi-annual offering periods. The grant price is determined by taking the lower close price from either the first or last day of the offering period and discounting it by 15%. There are no holding period requirements once granted. For the last 5 or so years, I've contributed 5% of my gross salary via PR deduction. Despite conventional wisdom, I've adopted a buy-and-hold strategy that has resulted in a nice return, as the value of my company's shares has appreciated considerably.

Now that I've amassed a small nest egg, I'm curious to know if I should alter my strategy. I'm considering the cessation of payroll deductions, and in turn contribute to the plan via lump sump purchase. I would generate the future lump sump contribution via the sale of qualified shares that have already been granted. Going forward, I plan to max out my annual contribution up to the IRS limit ($25,000-15%=$21,250). Currently, I contribute less than $10k annually. Once granted, I would sell the shares and use existing share to finance the subsequent year's purchase.

As I see it, the benefits to this strategy are:
*Potential for greater (dollar) return (15% guaranteed + potential appreciation during offering period, assuming shares are sold when granted)
*Reduced exposure to my company's stock
*Sale proceeds in excess of $21,250 each year would be a new source of cash that can be reinvested in a low-cost, diversified index fund

The negatives may be:
*Large taxable event, although the first sale would receive favorable treatment since only qualified shares are sold
*Not infusing organic cash into savings, as payroll deductions would stop

What are your thoughts? If needed, I'm a single filer firmly in the 25% federal tax bracket, 0% for state. The ordinary income generated from a sale would not push me into another bracket.

Thank you in advance!

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prudent
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Re: ESPP Strategy & Advice

Post by prudent » Sat Mar 18, 2017 9:30 am

Bump for a new member.

ved
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Re: ESPP Strategy & Advice

Post by ved » Sat Mar 18, 2017 10:18 am

You didn't provide $ you already have in the ESPP, and what is the qualified amount. So, I am going to make some guesses, so that I understand what you are trying to do.

Let's say you have accumulated $100k in the ESPP, of which about $40k is qualified.

In Year 1:
You are planning to sell $25k of the qualified shares, pay LT tax on the gains.
Then, you are planning to buy ESPP shares for $25k, and immediately (or soon after) sell them - these would be non-qualified shares, so ST gains.
Then, invest the proceeds to buy index funds.

You plan to rinse and repeat until all the shares in the ESPP are depleted (probably another 3-4 years, depending on how much you have).

The plan sounds ok to me, as you are trying to achieve 2 things: reduce your exposure to the company's stock, and take advantage of the discount for the $25k worth of shares each of the next 3-4 years.

What I would also suggest is to take the payroll contributions you used to make to purchase ESPP - and invest that in index funds.

The only thing is that you will still be exposed to your company's stock performance for a few more years. Only you can assess that risk vs. the tax hit for disqualifying disposition of all the shares.

jmangi5
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Joined: Thu Dec 05, 2013 2:48 pm

Re: ESPP Strategy & Advice

Post by jmangi5 » Sat Mar 18, 2017 12:11 pm

ved wrote:
The plan sounds ok to me, as you are trying to achieve 2 things: reduce your exposure to the company's stock, and take advantage of the discount for the $25k worth of shares each of the next 3-4 years.

What I would also suggest is to take the payroll contributions you used to make to purchase ESPP - and invest that in index funds.

The only thing is that you will still be exposed to your company's stock performance for a few more years. Only you can assess that risk vs. the tax hit for disqualifying disposition of all the shares.


Thank you, ved!

I wanted to pose my situation to the community to make sure there were no major flaws in this strategy. I think I will follow your advice and reinvest the payroll contribution. It dawned on me that I could also increase my 401k contribution with those funds as well.

Jack FFR1846
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Re: ESPP Strategy & Advice

Post by Jack FFR1846 » Sat Mar 18, 2017 12:33 pm

Well, the flaw in your plan is this: What if the stock drops to the point that it's below your "buy" price for shares you're holding?

I have a similar plan to yours and contribute 10% (the max they allow) and in advance check the "sell all shares at vestment" box. I am guaranteed to make money. I have tried what you're saying and lost my shirt (bought at 48 and sold at 12 when the stock tanked).
Bogle: Smart Beta is stupid

jmangi5
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Joined: Thu Dec 05, 2013 2:48 pm

Re: ESPP Strategy & Advice

Post by jmangi5 » Sat Mar 18, 2017 5:47 pm

Jack FFR1846 wrote:Well, the flaw in your plan is this: What if the stock drops to the point that it's below your "buy" price for shares you're holding?


Jack - You make an excellent point; however, one of the benefits of my employer's plan is that the share price is determined by taking the lower close price of either the first or the last day of the offering period.

fogalog
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Re: ESPP Strategy & Advice

Post by fogalog » Sat Mar 18, 2017 7:11 pm

jmangi5 wrote:
Jack FFR1846 wrote:Well, the flaw in your plan is this: What if the stock drops to the point that it's below your "buy" price for shares you're holding?


Jack - You make an excellent point; however, one of the benefits of my employer's plan is that the share price is determined by taking the lower close price of either the first or the last day of the offering period.


[ I suspect that Jack is referring to the fact that that is only true for the offering period itself. Once you have purchased the shares, and are holding them, the price of those shares could conceivably go down below the price at which you purchased them. Since you are proposing to sell shares that are beyond the withholding time limit, that is a very real risk, unless I misunderstood your plan...? ]

You receive a guaranteed 15% every 6 months on the money you invest, up to $21k per year. I would invest the maximum from payroll, up to the Federal limit, sell immediately on vest, and diversify with the proceeds. It's free money. I did this myself for many years.

Good luck!

fogalog
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Re: ESPP Strategy & Advice

Post by fogalog » Sat Mar 18, 2017 7:16 pm

One other thing you didn't mention.

For qualified disposition (ie LT CGT), don't you normally have to satisfy two withholding periods - both 1 year from vest (purchase) and 2 years from the beginning of the offering period?

It is a while since I've done this so things might have changed.

dowse
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Re: ESPP Strategy & Advice

Post by dowse » Sun Mar 19, 2017 11:51 am

My own experience with an ESPP was a learning one. The plan I participated in had similar rules to the OP's plan, except no lump sum option. I made two mistakes at first. The first mistake was not participating to the fullest extent allowed. The second mistake was to hold on to the shares after receiving them, foolishly thinking I "knew" something as an employee. I finally wised up, and decided the best strategy was to contribute to the max, then sell the shares immediately upon receiving them, thus locking in an "almost" guaranteed gain of 15%. I was happy to just take the free money. So, my advice would be to sell the shares immediately, pay the taxes and say "thanks for the free money". The market may have been kind to your company's stock in recent years as it has to many others, but that will not always be the case.

inbox788
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Re: ESPP Strategy & Advice

Post by inbox788 » Mon Mar 20, 2017 4:30 pm

dowse wrote:My own experience with an ESPP was a learning one. The plan I participated in had similar rules to the OP's plan, except no lump sum option. I made two mistakes at first. The first mistake was not participating to the fullest extent allowed. The second mistake was to hold on to the shares after receiving them, foolishly thinking I "knew" something as an employee. I finally wised up, and decided the best strategy was to contribute to the max, then sell the shares immediately upon receiving them, thus locking in an "almost" guaranteed gain of 15%. I was happy to just take the free money. So, my advice would be to sell the shares immediately, pay the taxes and say "thanks for the free money". The market may have been kind to your company's stock in recent years as it has to many others, but that will not always be the case.

This!

You should have bought as much as you could and simply sold it at first opportunity for 15%+ gain. Avoid concentrating in a single company and diversify into a total market fund. Did your company out perform the market? Are you willing to bet the farm that it will continue?

Now a couple of fine points. For the payroll deduction, what's the rule about 15% discount? Is it simply off the purchase price? Even if the automatic purchase was made last month? So you could sell it for a 15% gain over 1 month? Or is there a built in 6 month holding requirement, which would mean you may want to lump sump at the beginning of each period.
As far as selling your current holdings, you probably have some with long term capital gains (sell these now) and some that have only been held short term. If the gains are significant, you can hold them until they reach 12 months before you sell, but you are continuing to take extra risk.

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