Can An ESPP Save Your Retirement?

What do workers do with the company stock they buy through an employee stock purchase plan? Do they flip the stock or hold it long-term? Fidelity Investments researchers found that only 6% of employees “flipped” their stock, selling their shares within 10 days of purchase. More than half (57%) of employees under 30 sold all of their shares within two years, while 58% of employees over 60 held onto the shares they purchased for more than two years.

Millennials use ESPPs for short-term expenses and paying down debt. Older workers use ESPPs to build an emergency fund or a side retirement kitty to complement a 401(k).

How does an employee stock purchase plan work? You earmark aftertax payroll deductions to buy company stock in the plan. The dollars you contribute accumulate for a fixed period of time, typically 3 or 6 months, and at the end of that time period those contributions are used to buy company stock at a discount. (The IRS limit for how much stock you can buy is $25,000 a year; your employer might cap contributions at say 10% of your salary.)

The best ESPPs have a 15% discount, a “look back” provision that lets you buy shares at the lower of the price at the beginning or the end of the offering period, and no holding period--that means you can sell the stock right away after purchase, essentially guaranteeing a profit.

About one in five employers offer ESPPs, according to Aon Hewitt. Participation rates vary greatly; about a quarter of employees sign up at employers with the most generous plans, says Emily Cervino, a vice president in Fidelity’s stock plan services group, which serves 356 employers including Hewlett-Packard and Advance Auto Parts . (Hologic, a maker of women’s digital imaging equipment, boosted the terms of its ESPP, and participation more than tripled.)

Participation in an ESPP can “absolutely add up,” says Cervino. “A little comes out of every paycheck; it’s a relatively painless way to save and becomes a more significant form of savings for employees as the program rolls forward. It’s very easy to stick with.”

If you’re considering using an ESPP for the long-term, to supplement your retirement savings, you should have a strategy for selling the shares, paying taxes, and diversifying. If you sell at the time of purchase, the discount is treated as ordinary income, or you can hold the shares to qualify for long-term capital gains treatment. That’s how most (“qualified”) plans work. The tax rules for “nonqualified” plans treat the discount at the time of purchase as taxable income, and any subsequent gain or loss is treated as short or long-term capital gain depending on the timing of the sale.

Once the shares are purchased, they show up in a brokerage account linked to your stock plan account. Only a quarter of plans have holding periods—a year is common. Once any holding period is met, you can sell your stock and buy an index fund, or of course, hold onto it if you think your company is a good bet.