Employee Stock Purchase Plans: The Low-Hanging Fruit Too Many Employees Ignore
When employees review their benefits and compensation, most of their attention goes to the same areas. They think about how much they should contribute to their 401(k), whether they are taking full advantage of their employer match, what to do with their RSUs, and whether they should exercise their stock options. These are all important parts of a financial plan, particularly for employees whose compensation includes a meaningful amount of company equity. However, one benefit that often receives less attention is the employee stock purchase plan (ESPP).
That is unfortunate because, depending on how the plan is structured, an ESPP can be one of the more attractive and straightforward opportunities available in a compensation package. Many employees overlook it because it does not feel as significant as a large RSU grant or stock option award. The enrollment materials can also be confusing, often filled with terms like offering periods, purchase dates, discounts, lookbacks, qualifying dispositions, and disqualifying dispositions. As a result, it is easy to put off looking into the plan until later, and before long, another enrollment period has passed.
This does not mean that every employee should automatically contribute the maximum amount allowed under their ESPP. The decision should still take into account cash flow, emergency savings, debt, other financial priorities, and the amount of company stock an employee already owns. That being said, an ESPP should at least be evaluated rather than ignored. When you have the opportunity to purchase company stock at a meaningful discount, particularly when the plan also includes a lookback provision, it can be some of the lowest-hanging fruit in your overall compensation package.
What Is an Employee Stock Purchase Plan?
An employee stock purchase plan allows eligible employees to contribute a portion of their paycheck toward the future purchase of company stock. Those contributions are generally accumulated over a specific period of time, often referred to as an offering period or purchase period, and at the end of that period, the accumulated funds are used to purchase shares of the company's stock.
The details can vary significantly between employers, which is why it is important to look beyond simply whether your company offers an ESPP and instead understand the specific features of the plan available to you. Some employers offer a 15 percent discount, while others may offer a 10 percent or 5 percent discount. Some plans include a lookback provision, which can substantially increase the value of the benefit if the company's stock price rises during the offering period. Other plans may just apply the discount to the stock price at the time of purchase.
The first step is understanding exactly what your employer is offering. How large is the discount? Does the plan include a lookback provision? How long is the offering period? How often are shares purchased? How much can you contribute from each paycheck? Are there restrictions on when you can sell the shares? Two ESPPs that sound similar on the surface may provide very different financial opportunities, based on the answers to those questions.
The Discount Can Create an Immediate Advantage
The most obvious reason to consider participating in an ESPP is the discount. When you purchase stock in a traditional brokerage account, you generally pay the current market price. If the stock is trading at $100 per share, you pay approximately $100 per share, and the stock must increase in value before you have an unrealized gain. An ESPP can change that equation by allowing you to purchase the stock for less than its current market value.
For example, assume your company's stock is trading at $100 per share, and the ESPP provides employees with a 15 percent discount. Rather than purchasing the shares for $100, you would be able to purchase them for $85. At the time of purchase, the shares may still be worth $100 in the market even though you only paid $85. That difference represents an immediate economic benefit before considering any future appreciation in the stock.
Of course, purchasing stock at a discount does not eliminate investment risk. The stock price can decline after the shares are purchased, and some plans or company trading policies may prevent you from immediately selling the shares. However, the discount provides a cushion that does not exist when purchasing the same stock directly in the market. The larger the discount, the more significant that advantage can become.
This is why employees should not automatically dismiss their ESPP as just another benefit that is too complicated to understand. If your employer is willing to sell you stock for less than the current market value, that deserves a closer look.
The Lookback Provision Can Make an ESPP Even More Attractive
The discount alone can make an ESPP worthwhile, and a lookback provision can make it even more attractive. A lookback generally allows the plan to determine the purchase price using the lower of the stock price at the beginning of the offering period or the stock price at the end of the purchase period. The employee discount is then applied to that lower price.
Let’s say your company offers a six-month ESPP with a 15 percent discount and a lookback provision. At the beginning of the offering period, the stock is trading at $100 per share. By the end of the six-month period, the stock increased to $150 per share. Without a lookback provision, a 15 percent discount applied to the $150 purchase date price would allow the employee to purchase the shares for $127.50. With a lookback provision, the plan may instead use the $100 stock price from the beginning of the offering period because it was lower than the $150 price at the end. Applying the 15 percent discount to that $100 price would result in a purchase price of $85 per share. This means you would be purchasing stock currently worth $150 for $85!
That combination of a discount and a lookback provision is where an ESPP can become compelling.
Not every ESPP includes a lookback, but employees should understand if theirs does. It is one of the first features I review because it can significantly change the value of participating in the plan.
Participating in the ESPP and Holding Company Stock Are Two Different Decisions
One of the most important distinctions when discussing an ESPP is that the decision to participate in the plan is separate from the decision to hold a large amount of company stock over the long term, even though these decisions are often treated as if they are the same.
An employee may determine that participating in an ESPP makes financial sense because they are being offered the opportunity to purchase shares at a meaningful discount. They could also decide that holding those shares for an extended period is not appropriate because they already have significant exposure to their employer.
This distinction is important for employees who receive RSUs, stock options, or other forms of equity compensation. Their salary is already dependent on the company. Their career is connected to the company. A meaningful portion of their compensation may also fluctuate based on the company's stock price. Continuing to accumulate and hold additional shares through an ESPP can increase that concentration even further.
If the company experiences financial difficulty, the employee could face a declining stock price at the same time their employment or income is affected. That is why concentration risk should be part of the conversation whenever an employee owns a significant amount of their employer's stock.
However, this does not necessarily mean an employee should avoid participating in the ESPP. Depending on the rules of the plan and the company's trading policies, an employee may decide to participate, receive the benefit of the discount, and then sell the shares after they are available to be sold. This allows the employee to consider the value of the ESPP separately from the question of whether they want to maintain a long-term investment in their employer.
There are still risks involved. The stock price can change between the purchase date and the sale date, and trading restrictions or blackout periods may affect when shares can be sold. But, my point is that participating in an ESPP does not automatically require you to continually build a larger and larger concentrated position in company stock.
The Tax Benefits Can Be Attractive, but Should Not Drive the Decision
Tax-qualified employee stock purchase plans, often referred to as Section 423 plans, can provide favorable tax treatment if certain holding period requirements are met. Generally, a qualifying disposition occurs when the shares are held for more than two years from the beginning of the offering period and more than one year from the purchase date.
When those requirements are satisfied, part of the gain may receive long term capital gain treatment rather than all of the gain being treated as ordinary income. This can provide an additional benefit for employees who are comfortable holding the stock and have a longer term investment objective.
However, the potential tax savings should not be the only reason an employee decides to continue holding the shares. The desire to receive more favorable tax treatment needs to be balanced against the risk of having too much of your financial life tied to a single company. This is particularly important if you already receive significant RSUs or stock options, as holding ESPP shares for the required period could further increase an already concentrated position.
Sometimes paying more in taxes while reducing concentration risk can be the better financial decision. The goal should not be to minimize taxes at all costs, but rather to make decisions that improve your overall financial situation.
An ESPP Can Also Encourage Consistent Saving
Another benefit of an ESPP is that it creates an automatic savings process. Contributions are generally deducted directly from an employee's paycheck throughout the offering period, which means you don’t have to make a separate decision each month about whether to save or invest additional money.
For individuals who have already established a solid financial foundation, this can provide another structured way to put money toward future financial goals. Of course, an ESPP should not necessarily take priority over everything else. An employee who does not have an emergency fund, is carrying high-interest credit card debt, or is failing to contribute enough to receive a valuable employer match in their 401(k) may have other financial priorities to address first.
However, once those areas are under control, an ESPP can become another useful tool within a broader financial plan. Unlike a traditional retirement account, ESPP shares are generally held in a taxable brokerage account, which can provide additional flexibility. Depending on the employee's strategy, proceeds from the eventual sale of ESPP shares could be reinvested, added to emergency savings, used toward a home purchase, or directed toward another financial goal.
Not Every ESPP Is Created Equal
Although many employees should take a closer look at their ESPP, it is important to recognize that not every plan provides the same level of benefit. A 15 percent discount combined with a lookback provision can create a compelling opportunity, while a 5 percent discount without a lookback may require a more careful analysis. The length of the offering period, the timing of purchases, and the ability to sell the shares can also affect the potential return and the amount of risk involved.
An employee should also consider their personal financial circumstances before deciding how much to contribute. Participating in an ESPP should not come at the expense of maintaining an adequate emergency fund, paying down expensive debt, or taking advantage of an employer match in a retirement plan. The amount of company stock the employee already owns should also be considered. An employee who receives a small amount of equity compensation may be in a very different position than someone whose RSUs, stock options, and existing investments are already heavily concentrated in their employer.
The goal is not to accumulate as much company stock as possible because it is available through a benefit plan. Instead, the goal is to understand the value being offered and determine how it fits within your larger financial strategy.
Do Not Let Your ESPP Become an Afterthought
One of the biggest problems with employee stock purchase plans is not necessarily that employees evaluate the opportunity and decide against participating. More often, they simply never take the time to evaluate it at all. The enrollment period arrives, the plan documents are filled with technical language, and employees assume the ESPP is something they can worry about later.
The key is to understand how your specific plan works and then determine how it fits into your broader financial picture. Review the discount, understand whether a lookback provision exists, consider the length of the offering period, determine when the shares can be sold, and evaluate how much additional company stock you are comfortable owning. By separating the decision to participate from the decision to hold the shares for the long term, employees can make a much more thoughtful decision about how the ESPP fits within their compensation and investment strategy.
Wrapping This Up
Employee stock purchase plans are often one of the most overlooked benefits, particularly for those who already receive other forms of equity compensation. It is easy to focus on a large RSU grant or a stock option award and allow the ESPP to become an afterthought, but a plan that offers a meaningful discount can provide an opportunity that deserves attention.
When an ESPP includes a discount, you are being given the opportunity to purchase company stock below its market value. When that discount is combined with a lookback provision, the benefit can become even more compelling because the purchase price may be based on a lower historical stock price rather than the current market price. At the same time, participating in an ESPP does not mean you need to maintain a large, concentrated position in their employer's stock indefinitely.
Before the next enrollment period arrives, take the time to understand exactly what your company's ESPP offers and how it fits within your financial plan. Look at the discount, determine whether there is a lookback provision, understand the tax consequences of selling the shares, and consider how participation affects your cash flow and overall exposure to company stock.
Depending on how the plan is structured, your ESPP may be one of the simplest opportunities available within your compensation package. And, the biggest mistake you could make with it is overlooking it.
This material is purely intended to be general and educational in nature, and should not be construed as specifically-tailored investment, financial planning, tax, legal, or other professional advice. Information and data contained herein is as-of the date of publication, and may be subject to change in the future without notice. Any investment performance referenced is purely past performance, which is no guarantee of any future performance. Nothing contained herein should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or other financial product or investment strategy. All investment, tax, and financial planning strategies involve risk that you should be prepared to bear. You are highly encouraged to consult with professionals of your choosing before taking any action based on this material.