Are you lucky enough to be an employee who receives benefits in the form of equity? There is a mélange of ways companies can incentivize and reward their employees via equity, and employee stock purchase plans (“ESPPs”) are a well-known perk. This discussion will focus on qualified ESPPs, or Section 423 ESPPs, as they must meet regulatory requirements to offer tax advantages. In contrast, non-qualified ESPPs are more flexible regarding regulatory requirements but do not offer tax advantages. It is always prudent to check which type of plan you have before making any investment decisions.
ESPPs are relatively simple as far as contributions go. They are funded by after-tax payroll deductions and there is no withholding, not even for Social Security or Medicare. The deductions are held in the plan until a specified purchase date, at which point they are invested in company stock. Participants state the amount they want to contribute to the plan, which the IRS limits to $25,000 of the stock’s market value per year, and plans generally allow participants to elect deductions between 1% and 15% of a participant’s compensation.
ESPPs offer discounts and lookbacks. Most ESPPs build in a 10-15% stock price discount below market value. Then the lookback provision bases the purchase price not on the stock price at the time of purchase but on the price either at the beginning of the offering period or at the end of the purchase period, whichever is lower.
The tax treatment is a bit more complicated, but stay with me. When you sell the stock, you either pay ordinary income tax (called a disqualifying disposition) or long-term capital gains tax (called a qualifying disposition) on the gain, and you pay ordinary income tax on the discount. To receive the favorable long-term capital gains treatment, you have to hold the shares for more than one year from the purchase date and more than two years from the offering date. If you hold the shares according to these guidelines, you receive a lower percentage of ordinary income taxes and a higher percentage of capital gains taxes, which means you pay less in taxes overall.
Here’s an illustration of the tax treatment for both disqualifying and qualifying dispositions for those who are inclined.
Offering date price $10
Market price on purchase date $12
Purchase price @ 10% discount with lookback = $9
Sell price = $14
< 2 years from offering date and < 1 year from purchase date
Market price on purchase date – purchase price = ordinary income
$12 – $9 = $3 ordinary income
Sell price – tax basis* = short-term capital gain
$14 – $12 = $2 short-term capital gain
> 2 years from offering date and > 1 year from purchase date
Offering date price – purchase price = ordinary income
$10 – $9 = $1 ordinary income
Sell price – tax basis* = long-term capital gain
$14 – $10 = $4 long-term capital gain
*Tax basis = ordinary income + purchase price
In both examples, the tax burden is the same, a total of $5. However, the disqualifying disposition is broken down into $3 taxed at ordinary income rates and $2 taxed at short-term capital gains rates. The qualifying disposition is broken down into $1 taxed at ordinary income rates and $4 taxed at long-term capital gains rates. Therein lies the savings from observing the hold periods.
Let’s not forget about the discount either. While the 10% discount in the above examples may not seem like a significant amount, it can add up with share volume and is basically free money. What would you do if I offered to give you $10 in return for you giving me $9?
Accumulating shares over time through an ESPP can help build wealth. Still, you need to be careful not to end up with a concentrated position that exposes you to unnecessary risk should your company encounter adverse circumstances. You also need to account for your access to other stock-related benefits, including stock awards, restricted stock units, and stock options, and how this might add additional exposure. The key with all investing is diversification, so any ESPP holdings should be appropriately allocated within your global portfolio, which in and of itself should be rebalanced as your company holdings increase over time.
One of the top 10 questions I get from clients is should I open an HSA (Health Savings Account)? It is open enrollment season and HSAs have risen in popularity over the last few years, so let me take the opportunity to address the question here.
First, what are HSAs?
HSAs are personal savings accounts that can only be used for qualified health care expenses and out-of-pocket costs not covered by health plans. They offer tax benefits, spending flexibility, and portability.
Second, who is eligible?
To contribute to an HSA, you must be enrolled in a qualifying high-deductible health plan (HDHP). For 2022 the HDHP for individuals must have a deductible of at least $1,400 and an out-of-pocket medical expense limit of $7,050, and the HDHP for families must have a deductible of at least $2,800 and an out-of-pocket medical expense limit of $14,100.
Third, how do I get one?
You can enroll in an HDHP and an HSA through your employer if available, or find an HDHP on the health insurance marketplace and an HSA through a financial institution.
Here is a summary of the advantages and disadvantages of HSAs:
If you make contributions with pre-tax dollars, they are excluded from your gross income.
If you make contributions with after-tax dollars, you can deduct them from your gross income on your tax return.
Contributions can earn interest and be invested.
Your investments can grow and compound on a tax-deferred basis, which means there are no capital gains taxes on earnings.
Withdrawals are tax-free for qualified health care expenses.
You don’t have to make withdrawals in the year that the expenses are incurred (just save the receipts for the year in which you do make the withdrawals).
Any unused money at the end of the year rolls over to the next year (unlike Flexible Spending Accounts (FSAs)).
The account is always owned by you even if you change employers or terminate employment.
When HSA money is used to pay for health care costs in retirement, it has more buying power than money from retirement plans like 401ks where you will owe income taxes on withdrawals.
It can be challenging to budget how much to save as medical expenses are often unpredictable.
HSAs have low contribution limits – the 2022 contribution limit is $3,650/year for individuals with additional catch-up contributions of $1,000 between ages 55 and 65. (This amount is reduced by any employer contributions excluded from gross income.)
Once you enroll in Medicare at age 65 you can no longer contribute.
If you withdraw funds for nonmedical expenses before age 65, you will have to pay income taxes on the money and an additional 20% penalty. If you withdraw funds for nonmedical expenses after age 65, you don’t have to pay a penalty but you will have to pay income taxes on the money.
For an HSA to be worth it, you should be relatively healthy and good with recordkeeping. If this describes you, consider adding HSAs to your financial to-do list. “I don’t like tax savings” said no one ever.
Did you know that over 1.7 billion people worldwide do not have a bank account with a financial institution? (World Bank Global Findex Database 2017) The vast majority of these unbanked people live in the developing world, and overwhelming evidence demonstrates the positive correlation between financial inclusion and development. Without access to financial services, unemployed or low-income people are far worse off. Cash can be hard to manage, loans from family, friends, and loan sharks can come at a high cost, and the ability to manage financial emergencies can be severely compromised.
Microfinance addresses this basic unmet need. The goal of microfinance is to provide people who are typically excluded from the traditional banking system access to it, in the form of savings accounts, individual and group loans, agricultural loans that can be paid back when the harvest comes in, insurance, and education, among other services. These small working capital loans are also known as microloans or microcredit. Microloans do not require collateral, and can be distributed in small amounts and paid back over long terms. Like conventional lenders, microfinance lenders charge an interest rate and establish a repayment schedule. However, there is no profit motive.
What is the global reach of the microfinance movement? In 2018 $124 billion was distributed to 140 million borrowers, of which 80% were women and 65% were rural borrowers, and it is growing every year. (Microfinance Barometer 2019) With cash infusions from microfinance programs the data shows that borrowers are better able to feed their families, send their children to school, improve their homes, reinvest in their businesses, leave farming and become entrepreneurs, and put money aside for savings goals or to serve as an emergency fund.
The impact of technological innovation in this space cannot be overstated. With increasing ownership of cell phones and access to the internet in the developing world, the fast-growing fintech industry is better able to deliver financial platforms to rural populations. These software applications remove old obstacles and create new efficiencies. For example, the ability to make digital payments or send money transfers can eliminate travel time and cost, administrative work, and also reduce corruption.
Above and beyond financial inclusion, microfinance organizations seek to promote self-sufficiency and economic justice for underserved populations. In a global pandemic our struggles are amplified and this message resonates more than ever. To find out more, check out the crowdfunding site Kiva (I have no affiliation) to see how one of the largest and most well-regarded microfinance organizations embodies this spirit.