Confused About Your ESPP? Here’s What You Need to Know

Working for a company that offers employees an employee stock purchase plan (ESPP) can be a valuable perk that can help you reach your financial goals. It’s a benefit not all companies offer, so count yourself fortunate if your company offers one!

Unfortunately, many employees don’t take full advantage of their ESPP because they don’t completely understand how to use it to their advantage. Here are answers to seven common questions that employees have about their ESPP:

1. How does an ESPP work?

An ESPP allows you to purchase company stock at a discounted price, often between 5-15% off the fair market value. For example, if the fair market value on the applicable date is $10 per share, and your plan offers a 15% discount, you can purchase those shares for $8.50 per share. That’s like an automatic “profit” of $1.50 per share at the time of purchase if your plan allows you to sell immediately. While that profit could decrease, disappear or become a loss if you hold the shares and the share price decreases over time, it could also grow if the share price increases.

You make your contributions into the plan via payroll deductions and on set dates, the company purchases shares on your behalf (at a discount!) with the funds accumulated and delivers them to you. Like most company benefits, participation is optional for employees.

Terms to know:

• Offering period: The period of time during which your payroll deductions accumulate to purchase shares on your behalf.

 

• Purchase period: A shorter time period within the offering period. For example, a 12- or 24-month offering period may include a series of purchase periods.

 

• Purchase date: The date at the end of the purchase period on which shares are purchased for you.

 

• Purchase price: This is the price you pay for the shares on the purchase date and is typically set at a discount to the stock price (it’s an important price to know for tax purposes). 

 

2. Are all ESPPs the same?

No. The structure of each plan may vary slightly. The discount offered to participants may vary, for example, as can the length of the offering period and the number of purchase periods within the offering period. Some ESPPs also have additional features that can make them more valuable. One such feature, a “lookback,” compares the fair market value of the stock at the beginning of the offering period (the ‘offering date’) and the fair market value of the stock on the purchase date, then uses the lower value to calculate your purchase price. So, if the stock price is $10 per share on the offering date, and it increases to $15 per share on the purchase date, your purchase price is based on the lower $10 value. If your ESPP has a 10% discount, that means you pay $9 per share for shares that have a fair market value of $15 per share on that day!

3. What happens if I enroll in my company’s ESPP and then change my mind?

Participation is voluntary, so companies commonly allow you to withdraw, even in the middle of an offering period. Most plans also allow you to withdraw during the purchase period. Any contributions are then refunded, and you can choose to enroll again during the next enrollment window if you choose. Check your employer’s plan for details concerning withdrawal from the program, refunds and re-enrollment.

4. How do I participate in an ESPP?

It’s just as easy as participating in a 401(k) plan. You choose the percentage of your paycheck you wish to contribute, and your company will deduct those contributions from your net (after-tax) paycheck. Your employer will hold those contributions in a company account until the purchase date and make the purchase on your behalf. Your enrollment will typically roll over from one purchase period to the next unless you change it.  

One important note on choosing your contribution level: Like your 401(k) contribution percentage, the percentage you choose to contribute will be based on your gross (before-tax) pay amount. Say your paycheck is $2,000 and you elect to contribute 10% of your pay to your ESPP, $200 will be deducted from your paycheck each pay period.

In addition, if you participate in a tax-qualified ESPP, federal tax rules limit ESPP purchases to a maximum of $25,000 worth of company stock per calendar year.¹

5. What are the tax implications of participating in an ESPP?

You may owe taxes either when shares are purchased and sold or only when they are sold. The type of taxes you owe depends on the type of plan offered by your employer, and for tax-qualified ESPPs, on the timing of purchase and when you sell your ESPP shares. Specifically, if your company offers a tax-qualified ESPP, you may receive preferential tax treatment on your shares at sale if you sell them more than a year from the purchase date (when you receive the shares) and more than two years from the offering date.

The tax treatment on shares acquired via an ESPP purchase can be complex, just as with taxes on equity compensation in general. Be sure to discuss the potential tax implications of participation with a tax professional if you are considering enrolling in your company’s ESPP.

6. What happens if I buy shares through an ESPP and then leave my company?

The shares that you’ve purchased are yours to keep, regardless of whether you continue working for your company or the circumstances around your departure. Typically, any payroll contributions you’ve made that weren’t used to purchase shares will be refunded to you when you leave. 

7. How can participating in an ESPP help me reach my financial goals?

Purchasing shares via an ESPP can be an important tool in your financial toolbox to help you achieve your personal goals. If the stock price appreciates over time, and you continue to hold your shares, they could become a valuable part of your nest egg as retirement approaches. Or you can use them to reach shorter-term goals, such as buying a home or paying for college. How ESPP shares can help you reach your goals is up to you – start by defining your short, medium and long-term goals and line up where this workplace benefit can best help. Like with many investments, there are risks to investing through ESPPs if you hold onto them as shares may not appreciate in value over time and may be less valuable than they were when purchased. Speak to a Financial Advisor or tax professional to build an approach tailored to you.

And remember: an ESPP allows you to purchase stock at a discounted rate that’s not available to investors who do not work for the company. You don’t get opportunities like that very often!

Footnotes:

¹ The $25,000 may be increased in certain circumstances in which the purchase period crosses calendar years and the full limit is not used in the prior calendar year.