If you work for a publicly traded company or for one expecting to go public, chances are that you have access to an Employee Stock Purchase Plan (ESPP).

An ESPP is an employee benefit that allows you to periodically purchase shares in the company at a discounted rate. Essentially, employees contribute to the plan through payroll deductions, which build up between the offering date and the purchase date. At the purchase date, the company then uses the employee’s accumulated funds to purchase stock in the company for the participating employees.

Taking part in an ESPP can be an important part of your overall financial picture. However, before you enroll in such a program, you’ll need to strategize and consider the risks of holding a large chunk of stock in the firm you work for compared to other more common retirement savings vehicles, such as a 401(k).

How an ESPP can help you achieve your investment goals

When you stick with your Employee Stock Purchase Plan, you’ll have a big chunk of stock coming your way every six months or so, presenting several opportunities to advance your financial goals. Here are a few possibilities.

1. Supplement your cash flow

When you first enroll in an ESPP, it may hurt to see that chunk of change coming out of your paycheck. But properly managed, you can ultimately end up with more after-tax “pay” compared to not participating. This is because as long as you can make it through the first purchase cycle, you can expect to sell your ESPP shares as soon as they vest for more than you paid for them. Even with a disqualifying disposition, you should come out ahead.

2. Save for near-term goals

ESPPs can help you more quickly fund your near-term goals, such as buying a home in the next year or two. Even after-tax, your rate of return from selling vested ESPP shares as soon as you receive them should be many times higher than today’s highest-yielding savings accounts. It’s like adding a power ball to your savings every time a new batch of stocks vest in your account.

3. Invest in long-term goals

ESPPs can also help you reach longer-term goals, such as retirement. Whether you hold company shares as a small part of your overall portfolio or diversify them periodically, the compounding of ESPP can add up quickly. Because your employer’s stock can be discounted between 5-15%, it can provide a nice margin of safety for your investments to help avoid losing money. If you are buying the stock over time, the risk drops even further.

4. Increased Tax Benefits

A major advantage of Qualified ESPPs is that you will not owe taxes at the time of purchase. Additionally, if a qualifying disposition occurs where the sale happens two years after the offering period and one year after the purchase date, your ordinary income would be the lesser of the sale price compared the actual purchase price paid, or the actual discount per share. The rest of the profit or loss would be taxed as long-term capital gains or losses.

In contrast, if a disqualifying disposition occurs where the sale happens within two years of the offering period, the difference between the purchase price and the purchase date market value would be taxed as ordinary income. Capital gains or loss on the sale would be the difference between the sale price and the purchase date market price and will be taxed as a long-term or short-term capital gain or loss depending upon the holding period. 

What to consider before you invest

As with anything in life, you can’t just jump all in, but what should you do before making some changes?

1. Do your research

Although the overall nature of ESPPs is generally the same no matter the company, the structure of each plan may vary slightly. For example, the discount offered to participants may vary, as can the length of the offering periods and the number of purchase periods within the offering period.

Some ESPPs also have additional features that can make them more attractive. One of these options includes a “lookback”, which compares the fair market value of the stock at the beginning of the offering period and the fair market value of the stock on the purchase date.

If, for instance, the stock price was $15 per share on the offering date and it increases to $20 per share on the purchase date, your purchase price will be based on the lower $15 value. If your ESPP has a 15% discount, that means you will pay $12.75 per share for shares that have a fair market value of $20 per share on the purchase date.

2. Make sure your finances are in order

Before you invest in your company’s ESPP, make sure your financial situation is first in order. Financial advisors often recommend you to fund an emergency fund with at least six months’ living expenses and to pay off all high-interest credit cards or other debts first. You’ll also want to make sure you’re contributing enough to your 401(k) to get your employer’s match.

3. Avoid overexposure

If you decide to take part in an ESPP, be aware of how much overall exposure you’ll have. For instance, there is a good chance that you could already be invested in the company in your 401(k). Plus, your 401(k) match or bonus could be in company stock. And, your employment is with the company.

Keep in mind that the share price within the company may not go up. If your concentration in the stock grows too large, you may not see the necessary gains compared to investing in other companies or mutual funds.

To make sure you’re on the right path, create a plan to divest the shares periodically after taking advantage of the discount and the long-term capital gains treatment.

4. Understand stock plan rules when you leave the option

When participating in an ESPP, the good news is that the shares you’ve purchased along the way are yours to keep, regardless of whether you continue working for your company or the circumstances around your departure. However, if you are transitioning out of the company, it’s important to not ignore your stock options.

Under many ESPP rules, you traditionally have between 60 to 90 days to exercise any existing stock options grants. This will limit your tax-saving strategies and you could be hit with a tsunami of taxation if you have to exercise a career of stock options in one calendar year. Also, if you are choosing to leave, make sure you are aware of vesting schedules before giving notice and the date of your last day of work. Leaving a few days early could be quite costly. To avoid this, you may need to work a few extra days or weeks to hit the next year of vesting if your situation carries some flexibility.


*This article is intended to be informational only; it is not financial advice. 

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Brandon Osgood is a strategic communications and digital marketing professional based out of Raleigh, NC. Beyond being a passionate storyteller, Brandon is an avid classical musician with dreams of one day playing at Carnegie Hall. Interested in connecting? Email him at brosgood@outlook.com.