What to Know Before Participating in an Employee Stock Purchase Plan

by Chad Hileman October 1st, 2021

Have you been offered an employee stock purchase plan (ESPP) in your compensation package? An ESPP allows you to buy your company’s stock at a discount, defer tax payments on the gains until you sell the shares, and take advantage of additional tax benefits depending on how long you hold onto the shares. Below are frequently asked questions regarding ESPPs and what you should keep in mind before participating in your company’s plan.

Should I Participate in My Company’s ESPP?

While particular to your financial situation and risk tolerance, you can better inform your participation by evaluating what your plan entails—the more generous the policy, the better. Review your company’s ESPP policy, as they typically differ from company to company, and look for two features:

  1.     What is the stock purchase discount? Plans typically allow employees to buy at a discount of between 5% and 15% and contribute a maximum of $25,000 per year. All else being equal, plans with a larger discount are more advantageous.
  2.     Is there a “lookback” provision? A typical ESPP allows employees to contribute from their paycheck over a six-month period.  Some plans apply the discount to the stock’s price on the purchase date. However, some plans include a lookback provision, which compares the share price at the beginning of the offering period and the share price on the purchase date and uses the lower of the two values to calculate your purchase price. Plans with a lookback provision are more attractive because your acquisition prices tend to be lower.

A combination of a large discount, such as 10–15%, and a lookback provision can make an ESPP a compelling investment opportunity.

How Much Should I Contribute to My ESPP?

If your plan offers generous provisions, next consider the following factors: 

  • If you lack additional cash flow for making investments or risk having too much exposure to your company stock, you may decide to contribute less to your ESPP or not at all.
  • If you can comfortably contribute a portion of your paycheck to purchasing stock and have a well-diversified portfolio, you may even consider a maximum contribution.

When Should I Sell My Acquired Shares?

The answer to this question depends on a variety of factors, such as the tax impact of the sale, the amount of exposure you have to your employer’s stock, and your cash flow situation. The tax issues can be complicated, so we recommend working with an accountant to understand how the taxes will impact you.  

One key tax consideration for ESPPs is known as a “qualifying disposition.” Qualifying dispositions allow for more of the gain on the sale of stock to be taxed at long-term capital gains tax rates rather than ordinary income rates. To be regarded as a qualifying disposition, the shares must be held for more than two years after the grant (offering) date and more than one year after the purchase date.  

While ESPP considerations differ by individual, participating in your company’s plan may be worthwhile. Reach out to learn more about how we help our clients evaluate ESPP decisions and navigate the complexities of their financial lives.

To navigate the various strategies and scenarios, contact our team and we can walk you through your options.

As Director of Investment Research, Chad manages the firm’s research activities, including asset allocation research, factor analysis, manager due diligence, and the development of capital market assumptions. In addition, Chad leads the firm’s delivery of financial planning services and serves as the primary advisor for high net worth and institutional clients.

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