So youve started a new job and the company offers stock options as part of its benefits package.
Maybe you have no idea what that means, or youre not quite sure how to get started.
Here are some basics you should know.
With either one, the benefit is the same: You profit when the company profits.
Obviously, the flip side of that is: if the companydoesntdo so well, your savings can plummet.
And in some cases, theyre offered in lieu of higher pay.
Beyond the basics, these two plans are pretty different; the main difference is in how theyre funded.
With an ESOP, your employer buys stock for you.
When your benefits kick in, those stocks are yours.
But you dont have access to the money earned from them until you retire or leave the company.
In this way,its similar to a 401(k) plan.
With an ESPP, you contribute to the plan yourself through payroll deductions.
The good news is youll have access to the money sooneryou dont have to wait until you retire.
Its an inherent employee benefit.
With an ESPP, youre paying with your own money, but there are still benefits.
For one, many employers will offer a match.
Meaning, for every dollar you invest in the plan, theyllmatch youup to a certain percent.
Theyre still giving you free stock, just with a caveat thatyouhave to buy in too.
Plus, some employers even offer discounts on their stock.
Even better, some plans include a lookback provision, which could result in an even bigger discount.
Of course, the market fluctuates, and so will the value of your companys stock.
But youre still buying it for less.
Yes, the returns can be tempting.
But when theres a potential for high reward, theres almost always a potential for risk.
If the company tanks, your returns dont really matter.
Its not smart to invest too much in a single asset.
You want to be invested in a variety of companies, markets, industries and even financial vehicles.
Yes, most experts recommend taking that employer stock match, if offered.
But not at the expense of over-investing.
The bottom line: You dont want your entire income stream to be dependent on a single company.
How much should you contribute?
Even if your employer offers a match, you might not take them up on the full amount.
Its more important to invest your money wisely than it is to get that discount.
If the company isnt doing so well, you might consider selling before it hits rock bottom.
Its not a retirement plan.
Once youre vested (more in that in a minute), the stock is yours to sell.
Of course, if the stock price goes up after you sell, you might be kicking yourself.
How vesting works
With either option, your company probably has avesting period.
For example, with most ESOP plans, youre not vested at all when youre first hired.
After a year, you might be vested at 20%.
After six years, you might be fully vested.
The rest goes back to your employer.
With an ESPP plan, youre simply not allowed to sell your stock until youre vested.
How to enroll in your plan
With an ESOP, youre usually automatically enrolled when youre hired.
But well get into those options later.
With an ESPP, enrollment is a little more complicated, but its still pretty easy.
Purchase period: A time frame the company stock is actually purchased.
Investopedia explainsthat most offering periods include several purchasing periods.
So a plan might have a three-year offering period with four purchase dates or periods.
Once youve decided to participate in the plan, youll enroll at the next available offering date.
Youll fill out an app and indicate how much you want to contribute.
Usually, this amount is limited to about 10% of your after-tax pay.
(The IRS also limits contributions to $25,000 per year.)
Once that date hits, youll have an account that includes your stock purchase.
If you cash out, youll pay taxes on this amount, and itll be taxed as ordinary income.
ESPP contributions are made with after-tax dollars.
Of course, if your company has been profitable, youve probably earned a return on your stock.
This return is called a capital gain, and youwillpay taxes on that when you cash out.
You dont want the majority of your net worth tied up in your company.
This post was originally published in 2015 and was updated on June 16, 2020 by Lisa Rowan.
