What Is an Employee Stock Purchase Plan and Should You Participate?
Does your employer offer an employee stock purchase plan? Congrats! You may be eligible to buy stock at a discount and take advantage of unique tax benefits. Let’s break down the different types of plans, advantages, potential risks, and more.
What Is An Employee Stock Purchase Plan?
An Employee Stock Purchase Plan (ESPP) is a company-run program that allows employees to purchase company stock for a discounted price—usually between 5%-15% below market value. Typically, employees contribute through payroll deductions that build up between the offering date and the purchase date. At the purchase date, the company uses the employee's accumulated funds to purchase stock on behalf of the participating employees.
Understanding The Types of ESPPs
Not all ESPPs are the same, and each program’s structure can vary. These programs are broken down into two categories: qualified and non-qualified plans. Qualified plans, also referred to as 423 plans, have several restrictions that participants should be aware of:
They require the approval of the shareholders 12 months before implementation
All plan participants (employees) have equal rights in the plan
These plans cannot be offered for more than three years
There are restrictions on the amount the stock can be discounted
Participants in a qualified ESPP can take advantage of tax benefits because the ‘discount’ is not recognized as taxable income until the stock is sold. Non-qualified plans have fewer restrictions than qualified plans, but they don't have the same tax advantages regarding after-tax deductions as qualified plans.
How Does An ESPP Work?
The discount offered to employees varies between plans, but it can be as much as 15% off the fair market value. For example, if the fair market value is $20 per share, and your plan offers a 15% discount, you can purchase those shares for $17. That means your stock is profitable the moment you buy it!To better understand how ESPPs work, you need to know 4 key terms:
Enrollment period: The enrollment period is when you choose to enroll in the purchase plan or not. Remember that ESPPs are a benefit, and you are not required to participate.
Offering period: Employees can participate in a company ESPP only after the offering period has begun. The period begins on the offering date corresponding to the stock option plan's grant date.
Purchase period: This subset of the offering period occurs roughly every 6 months.
Purchase date: The purchase date will mark the end of the payroll deduction period, and this is when the shares are purchased for you. Some offering periods will have multiple purchase dates.
Participating employees decide the amount to be deducted from their paycheck that's contributed to the ESPP, but the IRS restricts total contributions to $25,000 annually.It’s important to note that employees that own more than 5% of company stock are not allowed to participate in an ESPP. In addition, ESPPs are usually only offered after the employee has been with the company for a certain period.
The Benefits Of Utilizing An ESPP
Taking advantage of an employee stock purchase plan can be a great way to meet your financial goals. The most significant and most obvious benefit is being able to purchase stocks at discounted prices. If you work for a high-performing company, the discounted stock rates can earn you significant gains. Those gains can be used to invest in long-term goals like retirement, save for short-term goals such as purchasing a house or a car, or simply supplement your current cash flow.Typically, shares purchased by employees aren't on a vesting schedule and belong to the employee immediately after purchasing.
The Risks Of Participating In An ESPP
There are always risks when it comes to purchasing individual stock. If too much of your portfolio is tied to company stock, you could be at risk of significant losses should the stocks go south, and if those stocks go south, it could also impact your career. So your stock investments are at risk, and your job could also be.Before you enroll in your organization’s employee stock purchase plan, ask yourself a few questions:
Would you buy this stock if it wasn't discounted? Remember, just because something is on sale isn’t suitable for you. You should only purchase a discounted stock if you would also buy it at the total price.
Does the stock have a good outlook? No one wants to invest in a sinking ship, even at a discount.
Does it fit nicely into your portfolio? If this investment further complicates your portfolio or does not fit your risk tolerance, it may not be a good match.
Decide With Your Trusted Advisor
Employee stock purchase plans can be complex and vary, so what you experienced at one company may differ from where you’re now. Our team can help decipher your ESPP, discuss any potential tax implications, and review your investment portfolio so you feel confident in deciding whether to enroll. Get in touch today.
