What is an Employee Stock Purchase Plan (ESPP)?

As society and technology has evolved over the years, more and more individuals care deeply about where they work, how they fit into their workplace culture, and the values of these companies. In fact, according to Gallup, 60% of Millennials are open to new job opportunities, leading us to believe that this generation isn’t as loyal as generations past.

This means that companies, now more than ever, need to entice candidates to want to work for them AND to stay put to help the company grow and maintain success. While salary and benefits are usually part of any job negotiation, companies continue to look for unique ways to incentivize people to work for them. One of those ways is through an Employer Stock Purchase Plan so this post is dedicated to explaining how these plans operate.

What is an ESPP?

An ESPP is an employer-provided benefit for public companies where, as an employee, you have the opportunity to buy your company stock, most commonly at a discount. Companies want their employees to have a vested interest in what they do and this is a nice way to get employees to work hard in hopes of the continued growth of the company (and its stock price).

How do I contribute?

Employers will provide details about how to enroll in the plan but be sure to note the dates of enrollment because if you don’t elect to enroll during the timeframe set for enrollment, you may have to wait six months to one year before you have the opportunity to contribute. When you enroll, you get to decide how much you want to contribute from your salary towards this plan. The most you can legally contribute is $25,000 per year, although you need to check with your specific employer because their plan may dictate a different amount. Once you decide on the amount and elect that during the enrollment period, (usually documented as a percentage of your salary), the employer will automatically start taking that from your pay during the “Purchase Period.”

What is the Purchase Period?

Your employer plan will provide not only when you need to enroll but also when the purchase period is for your plan. Each employer has different time frames so check your specific employer plan to determine the details. The stock is not purchased each time you are contributing from your paycheck, it’s just accumulating in an account that will be used to purchase these shares at the purchase date.

What is Purchase Date?

Typically, the day before the next purchase period is when the shares actually get purchased. Most employers have it structured to look at the price at the beginning of the purchase period and the last day of the purchase period and allow you to purchase at the lower of those prices. Most employers also have a discount they offer (for example 15% off the cost of the shares). These purchased shares are in a brokerage account in your name and you can do what you please with them. If your plan is a qualified plan, taxes aren’t paid until you sell the shares and as long as you hold onto the shares at least one year after buying them and wait at least two years from beginning of the purchase period, long-term capital gain tax applies to the growth of the stock. The discount amount (i.e. 15%) is always taxed as ordinary income. If your plan is non-qualified, you will be responsible for the taxes in the year in which they are purchased.

Finally, many ESPPs have a lookback provision which may allow you to look at the last day of the previous purchasing period and if that is the lowest price, you can lock that in rather than the beginning or end of the current purchase period.

Let’s look at an example:

Enrollment is in May as listed above on the timeline. You enroll in May and the purchase period begins June 15th. The “Purchase Price” on June 15th is $150. Between June 15th and December 14th, your employer is taking between 2% and 15% (depending on what you elect) out of your paycheck to put in an account that will purchase these shares. On December 14th, your employer looks at the share price in June vs. the share price now and purchases shares for you at the lower price. In this example, the lower stock price is at $140 and with the discount of 15% is purchased at $119/share.

The next purchase period begins December 15th and goes through June 14th. Again, the employer would look at the price for Dec 15th and June 14th to determine the purchase price before applying the 15% discount.

If we look at the last purchase period, we can see how a lookback provision might work. On the last December 14th of the timeline, your employer would usually look at December 14th vs. June 15th, however with the lookback provision, it could look at the last day of the previous purchase period which is June 14th and use that (assuming it’s the lowest priced).

Should you invest in an ESPP?

This becomes a personal question based on your own circumstances but some factors to consider include:

· Can I afford to contribute to it? (consider things like living expense needs, whether you have an appropriate emergency fund in place, other investment vehicles that maybe are better for your financial plan, etc.)

· What is the outlook of the company? (no one can know this for certain but does it seem to be continuing to grow, steady, etc.)

· What is the share price currently? How fast is it growing?

As always, talk to a financial professional when making these types of decisions and know that this doesn’t cover every single implication of an ESPP.

Sources: Adkins, Amy. “Millennials: The Job-Hopping Generation.” Gallup.com, Gallup, 16 Dec. 2019, www.gallup.com/workplace/231587/millennials-job-hopping-generation.aspx.

PHOTOCRED: @brucemars via @unsplash

Have questions or want to get in touch? Reach Maddi Napier, CFP®, MBA, QKA, FSRI at maddi@minervawealthplanning.com.