If you work for a public company, you may be offered an opportunity to participate in an employee stock purchase plan (ESPP).

These plans offer employees an opportunity to buy company stock at a discount, typically around 15%.

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How Do ESPPs Work?

ESPPs operate by deducting after-tax contributions from your paycheck, which are then used to purchase company stock at a discount. You can choose to contribute anywhere from 1% to 15% of your salary through payroll deductions. There are usually two enrollment periods each year, spanning six months, during which you decide how if and how much to contribute.

On the last day of the offering period, the company uses your accumulated payroll deductions to buy company stock on your behalf at the discounted rate. Some plans may include a “lookback” provision, where they use the lower share price between the beginning and end of the offering period to calculate the discount.

Here’s an example of how an ESPP with a lookback provision might work:

Offering Period: January 1, 2024 – June 30, 2024

On January 1, 2024, the stock price is $20 per share.

On June 30, 2024, the stock price has increased to $25 per share.

The ESPP offers a 15% discount.

With the lookback provision, the plan takes the lower share price between the beginning and end of the offering period, which is $20/share.

Applying the 15% discount to $20, you purchase the stock for $17 per share through the ESPP. Congrats, you are already in the green…

Some plans allow you to sell immediately without restrictions or blackout dates. I’ve even seen some plans that allow you to automate the sales. Just understand how it works for your specific situation.

 

Benefits of ESPPs:

The primary benefit of ESPPs is the ability to purchase company stock at a discount, often at the lowest price during the offering period. This can potentially lead to you immediately realizing a gain on your investment.

Risks of ESPPs:

ESPPs also come with risks. By allocating part of your income to buy company stock, you are sacrificing your take home pay and your cash flow. Additionally, having a large portion of your wealth tied to a single company can be risky, especially if the company’s fortunes change unexpectedly. Don’t drink too much of the corporate Kool-Aid…

Take into account if you are also receiving stock options from your company (ISOs or NSOs) as well as if you are receiving any RSUs.

How Are ESPPs Taxed?

Similar to your investments in non-retirement accounts, if you sell the shares within one year of purchase, any gains are taxed at your ordinary income tax rate. Holding the shares for longer than a year may qualify you for long-term capital gains tax, which for the average Joe will be around 15%.

Where ESPPs Rank in Financial Priorities:

Participating in an ESPP is a sweetener; a chance for you to have more skin in the game if you don’t have enough already. But participating in an ESPP should not be at the top of your financial priority list.

After you have adequate cash reserves, prioritized your retirement savings, maximizing employer matches when possible, then you can think about allocating part of your paychecks into an ESPP.

 

Final Thoughts:

ESPPs offer a great opportunity to buy company stock at a discount, but they require careful consideration due to their potential impact on cash flow and investment diversification.

Although they can be very similar, not every ESPP program is the exact same, so ensure you understand the specifics of your plan. Typically there is an annual limit on how much you can contribute to an ESPP. This can be capped by your employer or the IRS imposes a $25,000 annual limit that you can contribute.

Always review the specific details of your company’s ESPP before enrolling to ensure it aligns with your financial goals and risk tolerance.

Not sure if you should participate in your ESPP? Reach out to Munroe Morrow today.

www.mmwealthmanagement.com/get-started-now/

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Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All indices are unmanaged and may not be invested into directly.

All investing includes risks, including fluctuating prices and loss of principal.