Employee Stock Purchase Plans (ESPP) – The 10 Top Questions to Answer Before You Decide

1. What is an ESPP?

An employee stock purchase plan, or ESPP, offers an employee of a Company the chance to sign up and then purchase shares of their employer’s stock systematically at a discount from market value.

You decide the amount you want to contribute and this is withheld (after-tax) from your paycheck and collected during the offering period, which is normally 3 to 6 months.

At the end of the offering period, the Plan Administrator buys shares with your funds and deposits them to your account.  You can either hold them or sell them for a potential immediate profit!

Many employees participate in an ESPP because they like the fact that they get to buy the Company’s ESPP stock at a discount.  In some companies, this could be as high as 15%.

2. How can an ESPP help me with my financial plan?

ESPPs can be a useful way for you to contribute money directly from your paycheck into your employer-offered plan, and to accumulate wealth.

One of the main benefits is that even if you don’t like the Company’s stock itself, you’re getting a quick rate of return on your money by buying the stock and then selling it every 3 months or 6 months – as soon as you’re able to. And even as an after-tax rate of return, it could be as high as 7-9%, which is fantastic.

It’s also an opportunity to systematically save through payroll, which has the benefit of being automatic. You sign up for the plan, and the rest just happens. It’s similar to a 401(k) in that regard, and that “set it and forget it” quality is part of what makes those plans be so successful in helping people build wealth.

An ESPP is not only a great program to generate an attractive rate of return, but from there, to be able to sell it immediately and utilize the money for expenses, to diversify your portfolio, or to buy another asset.  Alternatively, some people elect to hold on to the Company stock for the longer term.

So, you want to understand what your cash flow is because an ESPP can be a very powerful tool. If you can get by without the money that’s going towards your ESPP contributions, it means you can make that money work for you.

3. Will I end up owning too much Company stock through an ESPP?

How much Company stock to own is a very individual consideration. Employee Stock Purchase Plans are often only part of a Company’s total compensation package – where a salary is part of it, a bonus could be part of it, and being given restricted stock units (RSUs) and other stock options might be another part of it.

Participating in an ESPP when you already have a lot of Company stock through these other options could put you in a concentrated stock position, where a large portion of your money is tied to one stock, and at risk, if that Company performs negatively versus the rest of the market.

Some of the questions we ask as we are working through the planning process include:

• What percentage of your overall wealth or portfolio is concentrated in this one Company’s stock?
• How large and established is the Company?
• Is the Company on a trajectory to continue growing and expanding?
• How much is it growing, and what does the future look like for the sector?
• In a worst-case type situation, how would your overall financial plan be affected in the case   that your Company stock declines by 30% or so?

It’s important to consider how comfortable you are with your Company stock, which might depend on your own goals, your risk tolerance, how much you have in liquid savings, and what the potential is for your Company.

4. Is an ESPP a good use of my money?

There’s no short answer here because it comes down to understanding each client and their individual needs. Our overall financial planning process will help us determine whether an ESPP is a good fit or not.

Part of planning is looking at your circumstances and asking the right foundational questions. How much do you have in checking and savings just for short-term needs? How much are you putting into retirement – what other plans does your employer offer, and are you maximizing those? What other monetary needs do you have? Are you comfortable being invested for some time, or do you have short-term financial goals that require liquid funds?

For a lot of people it makes perfect sense to participate in their ESPP, but to the dollar amount which you should be contributing – that depends on your situation. There is a maximum dollar amount that you can put into ESPP, but that doesn’t necessarily mean that you should be meeting it. If you’ve got plenty of excess cash and a healthy cash flow, then maybe it makes sense, but if you’ve got other shorter-term goals, maybe it doesn’t at this moment in time. Something else to consider is that participating in an ESPP will reduce your take-home income because part of your paycheck will be going toward buying the Company stock.

Coming up with a plan of how much to do and when to do it is something that requires an overall view of each individual’s unique situation and is something to work on with a financial planner.

The value of astute financial planning is simply immense, and that’s because it expresses your vision and builds your wealth towards achieving it. To find out what WestStar offers you within our comprehensive financial planning suite, click here.

5. How does an ESPP work?

The way an ESPP works is comparatively simple. You fund the purchase of shares over time through payroll deductions. Typically, every pay period the amount you invest is withheld from your paycheck and collected during the offering period – normally 3 or 6 months. At the end of that period, the Plan Administrator uses your contributions to buy whole shares of Company stock (however much you can purchase at the discount), and the remainder of the money is rolled over into the next period.

6. How does ESPP enrolment work?

Enrolment is usually done through a Company’s online HR system, but could also be through a brokerage service. You just log on and indicate that you want to sign up for the plan. On the application, you will state the amount you want to contribute each pay period – usually limited to 10% of your take-home pay – and it often takes effect immediately.

7. What is the offering period?

The offering period is every quarter or every 6 months for most companies. So if you decided you wanted to enroll in the ESPP, you would be enrolled at the start of the next offering period, which would most likely start at the beginning of the next quarter (or the quarter after that).

8. What is the purchase date?

The purchase date comes at the end of the offering period- it is the date that the money that’s been withheld gets invested in the actual stock, which is usually within a week after the quarter ends.

9. What is the purchase price?

Companies have different formulas for deciding on the purchase price. Some like to look at the discount off the average price the stock traded at during the offering period. Some may view the price at the beginning of the offering period, and others, the end.

Some companies utilize lookback pricing – where they’ll look back and see where the actual low point was for the stock price over the offering period and make purchases based on that ‘lowest price’ during the period. This can be super beneficial to employees: you get as big of a discount as possible.

There’s some variability, but you can always find the specifics in the Company’s ESPP Summary Plan Description.

10. How long is my money tied up in the stock?

Most companies offer a buy-in over every quarter or 6 months, which means that every pay period over the quarter or 6 month offering period, your contributions are pulled directly from payroll and accumulate in your account until the purchase date.

At the end of the offering period (on the purchase date), your money is used to buy shares that are transferred to your account, and you can sell these immediately if you choose.

With many ESPPs, employees can withdraw from the plan at any time before the purchase date. However, you should refer to your plan documents to determine your plan’s rules governing withdrawals.

How are profits or losses from ESPPs reported for income tax purposes?

The specifics of this can be tricky and can change on a case-by-case basis.

If you decide to sell the stock on the day that it vests, you’re going to pay ordinary income tax on the difference between what you sell the stock at and what it was purchased at. That’s not a bad thing, because since you’re buying it at a discount, you’re locking in the gain.  If you decide to hold the stock, you may be able to get a more favorable tax treatment if you meet certain holding qualifications. There could be reasons to take either path – your financial situation and plan become the determining factors.

WestStar Prosperity Partners

At WestStar Prosperity Partners we’ve helped professionals make the most of their equity compensation for years, giving them a clear view on how to optimize their stock positions and manage their tax obligations with confidence and clarity.

If you would like to discuss the benefits of having your equity compensation incorporated into a 360˚ financial plan, please contact us for a complimentary consultation. Click here to get in touch.

We wish you every success in the future and hope to hear from you soon.

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.

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