ESPPs: Employee Stock Purchase Plans (Easy Street Pretty Please?)

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.

Assumptions:
Offering date price $10 
Market price on purchase date $12
Purchase price @ 10% discount with lookback = $9
Sell price = $14

Disqualifying disposition:
< 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

Qualifying disposition:
> 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.

Your Next Healthy Habit: The HSA

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:

Advantages:

  • 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.

Disadvantages:

  • 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.

DIY Retirement Savings: SEP IRAs vs. Individual 401(k)s

Are you a free spirit not beholden to a boss who would like to sock away money for retirement in a tax-deferred savings plan that has higher limits than Traditional and Roth IRAs? This blog post is for you. Two fantastic options are the Simplified Employee Pension (SEP) IRA and the Individual 401(k) (aka the Self-Employed 401(k) or the Solo 401(k)). Both of these plans are easy to set up and administer, have high contribution limits, and offer funding flexibility.

The rundown on SEP IRAs:

  • Easy to open: SEPs are offered at most financial institutions that offer retirement accounts.
  • Funding: only by employers, not allowed by employees.
  • Funding flexibility: No minimum annual contribution amount. In flush years you can contribute more, in tough times you can scale back.
  • Contribution limits: You can contribute as much as 25% of your compensation (generally 20% if you’re self-employed[1]), up to $56,000 for 2019.
  • Eligibility: Almost any type of business can offer a SEP. It is best for self-employed individuals and small business owners. An employee is eligible to participate if they are at least age 21, worked for the company in 3 of the last 5 years, and received at least $600 in compensation during the year.
  • If you set up a SEP for yourself, you have to set one up for each eligible employee.
  • If you contribute to your own SEP, you have to contribute the same percentage to each eligible employee’s SEP.
  • Tax benefits: Tax-deferred contributions and investment growth, tax-deductible contributions.
  • Loans: Not allowed.
  • Vesting: Immediate.
  • Administrative considerations: No additional IRS reporting.

The rundown on Individual 401(k)s:

  • Easy to open: Individual 401(k)s are offered at most financial institutions that offer retirement accounts.
  • Funding: only by business owners, in dual role of employer and employee.
  • Funding flexibility: No minimum annual contribution amount. In flush years you can contribute more, in tough times you can scale back.
  • Contribution limits: You can put away more money than with a SEP. This is because you can contribute both as an employee and an employer. As an employee, you can contribute $19,000 ($25,000 if you’re age 50 or older). As an employer, you can contribute an additional 25% of compensation (generally 20% if you’re self-employed), up to a maximum of $56,000 ($62,000 if you’re age 50 or older) for 2019.
  • Eligibility: Business owners who have no employees. This includes sole proprietors, LLCs, S and C corporations, partnerships, and tax-exempt organizations. You must have at least a 5% share in the business. Spouses can contribute if they earn income from the business.
  • Tax benefits: Tax-deferred contributions and investment growth, tax-deductible contributions.
  • Loans: Allowed, but depends on the plan administrator. Generally you can borrow 50% of the account balance, up to $50,000, and take up to 5 years to pay it back.
  • Vesting: Immediate.
  • Administrative considerations: Once your balance reaches $250,000, you have to submit IRS Form 5500 every year.

Both plans allow you to accumulate a formidable nest egg without being subject to the tax consequences of regular brokerage accounts or the low contribution limits of Traditional and Roth IRAs. Start early with smaller amounts and let the magic of compounding interest go to work for you. Or, start later and contribute the maximum possible – with such high contribution limits these plans are perfect for catching up.


[1] Business net profit from your IRS Schedule C, after subtracting out the self-employment tax deduction.

The Medicare Roundup

Medicare is a federal health insurance program that was established in the 1960s for individuals age 65 or older and for individuals under age 65 with kidney failure, ALS or certain other disabilities. It is funded by the taxes that workers pay to Social Security and Medicare, by the premiums that Medicare beneficiaries pay for their coverage, and by the federal budget.

Medicare has four parts: A, B, C and D. Part A and Part B are considered Original Medicare as they are provided directly through the federal government and Part C and Part D are not considered Original Medicare as they are not provided directly by the federal government.

Part A covers hospital insurance. This includes inpatient hospital care, skilled nursing, hospice care and home health services. This does not include long-term care. You don’t have to pay a premium for Part A coverage as long as you, your spouse, or your ex-spouse worked full time for at least 40 calendar quarters (10 years) and paid Social Security taxes, or if you, your spouse, or your ex-spouse are eligible for Railroad Retirement or Civil Service benefits. You do have to pay a premium if you worked and paid Social Security taxes for less time. If you qualify through your spouse or ex-spouse, you need to have been married for at least 10 years. Most Medicare beneficiaries qualify for this premium-free coverage.

Part B covers medical insurance. This includes outpatient medical care such as doctor visits, tests, preventative care, mental health care, medical equipment like wheelchairs and walkers, and some ambulance and home health services. You have to pay a premium for Part B coverage to the Social Security Administration. If you’re already receiving Social Security, the premiums are deducted from your Social Security benefit, otherwise Social Security bills you directly. The premium starts at a standard amount and increases for people with higher incomes. Each year the premium increases but current Medicare beneficiaries whose premiums are deducted from their Social Security benefit generally avoid the increase due to a hold harmless provision.

Part C is something of a misnomer as it doesn’t refer to a subsection of medical care like the other Parts. Instead, Part C refers to Medicare Advantage Plans, which are plans offered by private companies that have contracted with Medicare. Medicare Advantage Plans are required to provide all Part A and Part B benefits, but can do so with different rules, costs and restrictions. For example, with Medicare you can go to almost any hospital or doctor’s office whereas with Medicare Advantage Plans you can be limited to network providers. Many Medicare Advantage Plans replace Part A, Part B, Part D and Medigap coverages (more on Part D and Medigap below), as well as offering coverage for vision, dental and hearing services. You pay an additional premium for these plans on top of your Part B premium (and your Part A premium if you have one).

Part D covers prescription drugs and is offered by private companies. You can get Part D as a stand-alone private drug plan (known as a PDP) or as a part of a Medicare Advantage Plan with drug coverage (known as a MAPD). However, neither Medicare nor Medicare Advantage Plans cover prescription drug copayments or deductibles. As with Part B, the premium increases for people with higher incomes.

Medigap is supplemental insurance coverage offered by private companies that is designed to fill the gaps in expenses not covered by Medicare. Medigap covers Part A and Part B copayments, coinsurances and deductibles.

Depending on if you are employed or retired, there are different timelines for enrolling in Part A and Part B. However, once you are enrolled in Part A and Part B, there are several paths to getting enough coverage to address your long-term medical needs. If you just enroll in Part A and Part B, you would likely incur substantial out-of-pocket costs. To avoid this, you can enroll in Part A and Part B and supplement these benefits with Part D and/or Medigap coverages. Or if you have employer, retiree, or Veterans’ Administration (VA) medical benefits available to you, these programs can help defray costs. Or you can follow in the footsteps of 1/3 of Medicare beneficiaries and get your benefits through a Medicare Advantage Plan.

The ABCs of Maternity Leave in California

Deciphering the options for maternity leave can be a headache. Unfortunately, there is no de facto coherent program that makes maternity leave affordable for all women, so it’s up to the individual to piece together the options available and develop a plan that works for their unique situation. This post provides a basic snapshot of the different types of maternity leave available in California. It’s always advisable to consult with your human resources department on this topic, and helpful to consider these maternity leave benefits in advance of any discussion.

Family & Medical Leave Act (FMLA)
The FMLA is a federal law that entitles eligible employees of covered employers to take unpaid, job-protected leave for specified family and medical reasons with continuation of health insurance coverage under the same terms and conditions as if the employee had not taken leave.

To be eligible for FMLA, an employee must have worked for a covered employer for at least 12 months, worked at least 1,250 hours during the 12 months prior to the start of FMLA leave, and the company must have at least 50 employees within a 75-mile radius. Eligible employees are entitled to 12 weeks of leave in a 12-month period for the birth of a child and to care for the baby within one year of birth.

The 12 weeks of FMLA leave don’t have to be taken all at once. FMLA can be taken during pregnancy to obtain prenatal care or for any period of incapacity, or for the birth and care of a baby. Employers can require employees to use sick or vacation time while on FMLA leave, and employees can also elect to use vacation or sick time towards their FMLA leave.

California Family Rights Act (CFRA)
The CFRA is a state law that is similar to the federal FMLA law in terms of eligibility and coverage, and that provides 12 weeks of unpaid, job-protected leave with continuation of health insurance coverage. The primary difference between CFRA and FMLA is that CFRA does not include pregnancy leave. CFRA starts when the mother’s medical disability ends, which is generally 6-8 weeks postpartum, and does not have to be taken all at once. CFRA and FMLA can overlap, which means that most likely you would not get 24 total weeks of leave.

Notably, CFRA law compliments FMLA law by allowing women to take off time prior to delivery (with FMLA) but still maximize their time off with baby once it arrives (with CFRA), instead of having to work as close as possible to their due date to end up with more baby bonding time.

California Pregnancy Disability Leave (PDL)
This law applies to employers with 5 or more employees and allows a pregnant employee up to 16 weeks of unpaid, job-protected leave with continuation of health care coverage during the period in which she is unable to continue working due to pregnancy, childbirth, or a related medical condition. The 16 weeks of PDL don’t have to be taken all at once. Employers can require employees to use sick time during this benefit, and employees can elect to use sick time, but only the employee can choose to use vacation time.

California State Disability Insurance (SDI)
California law allows women to begin maternity leave 4 weeks before their due date (or earlier if a medical condition or pregnancy complication requires it). From the date of delivery, the law allows for an additional 6 weeks of leave, or 8 weeks for a C-section. This results in approximately 10-12 weeks total maternity leave for most women.

If you have paid into the California State Disability Insurance (SDI) system, you may receive SDI payments while taking your PDL as described above. This is paid out at about 55% of gross income up to the weekly maximum benefit amount, with a 7 calendar day waiting period before the benefit starts on day 8. Many women choose to take a week of sick or vacation time to cover this waiting period. However, employers cannot require employees to use sick or vacation time prior to receiving SDI.

California Paid Family Leave (PFL)
When PDL and SDI benefits end after 6-8 weeks, depending on the type of birth, you may be eligible for Paid Family Leave (PFL), which entitles mothers to up to 6 weeks of additional paid leave. Mothers will automatically receive a PFL form with their last SDI check. This benefit is paid out like SDI, at about 55% of gross income up to the weekly maximum benefit amount, and the 6 weeks don’t have to be taken all at once – they can be taken anytime in the 12-month period after the birth. Employers can require employees to use vacation time prior to receiving PFL but not sick time. PFL has no job protections, and so if you are eligible, you need to take this leave in conjunction with FMLA or CFRA leave.

The Bottom Line
Most women want to know how long can you be out on maternity leave and still get paid for it. In a nutshell, you can take off 4 weeks before your due date and 6-8 weeks after the baby is born under PDL, then take 6 weeks under PFL. That’s approximately 16-18 weeks of paid, job-protected leave, if you coordinate your PFL with FMLA and CFRA.