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Financial Planning: Strategies

What are the 10 most important financial-planning rules for employee stock purchase plans?

Before you participate in your company's employee stock purchase plan (ESPP), understand the following essential points for financial planning with ESPPs.

1. Set goals. Understand the value of your ESPP participation and how it fits into your life. What exactly do you want to do with the proceeds from the eventual sale of the shares? This consideration should include important life events and planning goals.

2. Know what type of ESPP you have. There are two types of ESPPs: tax-qualified and nonqualified. It is vital to know which you have.

3. Find out how purchase periods work, and understand the ESPP life-cycle. During a purchase period, payroll deductions are accumulated. The offering period and the purchase period can be the same length (e.g. six months), or the offering period can comprise two or more purchase periods. You should know the following: the maximum you can contribute (considering both your plan's rules and your available cash); whether you can increase or decrease your contribution amount during an offering; and how you can withdraw from the offering.

4. Understand purchase discounts and lookbacks. Your company will specify the discount before the offering begins. If your plan has a lookback feature, the discounted purchase price that you pay is based on the stock price at either the start or the end of the offering period, whichever is lower.

5. Learn the impact of job termination. If you leave the company, you will continue to own shares purchased for you during your employment, but your eligibility for participation in the plan ends.

6. Know the timeline of the ESPP holding periods. If your ESPP is tax-qualified, the tax consequences depend on whether you meet the holding periods required for favorable tax treatment. Also find out whether your company imposes its own mandatory holding period.

7. Understand ESPP taxation. Your tax treatment is determined by the length of the holding period after both the start of the offering and your purchase date. See related FAQs for examples of the tax treatment when the holding periods are met, when the holding periods are not met, and for nonqualified ESPPs. This also affects your tax-return reporting.

8. Decide whether you want to sell or hold the shares after purchase. Whether you hold the shares and for how long will affect your tax treatment when you sell them. Consider company trading blackouts and ownership or retention guidelines.

9. Watch tax rates in the year of sale. Anticipate what your tax rate will be in the year when you plan to sell ESPP shares. Yearly income above certain thresholds raises your rate of capital gains tax and triggers a Medicare surtax (see a related FAQ).

10. Beware of overconcentration in company stock. Consider sales of stock for healthy investment diversification.

To read a detailed discussion of all these topics, see the in-depth article on financial planning for ESPPs.

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