The Ins and Outs of Employee Stock Purchase Plans

Employee stock purchase plans (ESPPs) can be a valuable benefit for employees of publicly traded companies. However, before deciding to participate in your company’s plan, it is essential to have a thorough understanding of the rules and risks involved. According to financial experts, roughly half of public companies offered an ESPP in 2020, presenting an opportunity for eligible employees to take advantage of free money through discounted company shares.

While the potential benefits of an ESPP are enticing, it is crucial to evaluate your short-term financial priorities before committing to the plan. Certified financial planners emphasize the importance of considering other financial goals, such as investing in an employer’s 401(k) match, especially if you have limited income. It is essential to assess how comfortable you are with sacrificing cash flow during the offering period before deciding to participate in an ESPP.

During an “offering period,” typically lasting six months, ESPPs collect after-tax contributions from employees’ paychecks to purchase discounted company stock on a specific date. The best ESPPs offer a 15% discount with a “lookback provision,” which determines the stock purchase price based on the value at the beginning or end of the offering period, whichever is lower. This could result in significant savings for employees, with the potential to quickly sell shares after purchase to capitalize on immediate gains.

While the allure of discounted company shares may be tempting, it is essential to consider the tax implications and potential risks associated with ESPPs. Employees are required to pay regular income taxes on the discount received, as well as any gains realized after the purchase date. Additionally, the future performance of the company’s stock is uncertain, making it a gamble for employees who choose to hold onto their shares for an extended period.

Recent surveys have indicated a growing trend in ESPP offerings, with an increasing number of plans providing a 15% discount and incorporating lookback provisions. In 2023, 85% of qualified ESPPs offered a 15% discount, up from 70% in 2020. Similarly, the percentage of ESPPs with lookbacks has also risen, reaching 83% in 2023 compared to 64% in 2020. Despite these enhancements, experts advise employees to carefully review plan documents before enrolling to understand the plan’s qualifying status, offering period length, purchase dates, and potential consequences of leaving the plan.

While ESPPs offer an opportunity for employees to purchase discounted company shares, it is essential to weigh the benefits against the risks before opting into a plan. By evaluating your short-term financial goals, understanding the mechanics of ESPPs, and considering the evolving trends in plan offerings, you can make an informed decision that aligns with your financial objectives. Remember to consult with financial experts and carefully review plan details to maximize the potential benefits of participating in an employee stock purchase plan.