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4 ways an ESPP is a sweet deal

By Jennie L. Phipps · Bankrate.com
Friday, July 12, 2013
Posted: 11 am ET

Employee stock purchase plans, or ESPPs, are probably the most overlooked benefit in the retirement planning arsenal.

A survey by the National Association of Stock Plan Professionals reports that about two-thirds of companies offering these plans say they have an employee participation rate of 40 percent or less. Fidelity Investments, which manages about 250 ESPPs, says employees overlook these plans because they don't always understand or appreciate their benefits. Emily Cervino, a vice president of stock plan services, says ESPPs "gain value on the day that they are purchased."

If your company offers one of these plans and you're not participating, here are four good reasons to take another look.

Employees get a great discount. ESPP participants can usually buy stock at a 15 percent discount, although some companies offer something smaller. To sweeten the pot, there is usually a three- to six-month "look-back" period when the employee gets to pay the lowest available price with the discount on top of that. For instance, if your company's stock was $10 in January and rose to $15 by June, with a six-month look-back period and a 15 percent discount, you'd pay $8.50 a share. If the opposite were true -- the stock was $15 in January and dropped to $10 in June -- you'd still pay $8.50.

Payroll deduction is painless. Once you set your contribution rate, which can be as low as 1 percent at most companies, stock purchases are automatically made from your paycheck. There are some taxes, but in most plans, managing them is the company's responsibility. Generally, the money you spend to purchase the stock has already been taxed, so the Internal Revenue Service requires the company to deduct taxes on the discount it is giving you. It's a small amount, and prepayment keeps you from having to worry about it later.

ESPPs are flexible. Unlike 401(k)s or individual retirement accounts, if you really need the money, you can sell the stock and collect the cash with no penalties. You do have to pay taxes -- at the capital gains rate if you've held the stock for at least a year.

ESPPs can beef up retirement savings. Recent research found that participating in an ESPP can really pay off. The average employee who fails to sign up when an employer offers one of these plans forfeits $2,726 annually, calculates Ilona Babenko, assistant professor at Arizona State University, and Rik Sen, assistant professor of finance at Hong Kong University of Science and Technology. Babenko and Sen say that just buying the stock and holding it may not be the best approach. Many companies, they point out, allow employees to sell the stock as soon as they purchase it. Given the most common 15 percent discount, the immediate sale alone allows a healthy profit.

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