How employee stock purchase plans work
ESPPs are generally offered to all employees and can allow you to purchase company stock at a discount of up to 15%, capped at $25,000 per year for tax-deductible plans.
The plan collects after-tax contributions from each paycheck during an “offering period” and uses the funds to buy company stock on a certain date.
“The gold standard for a plan would be a 15% discount with a review feature,” said Bruce Brumberg, editor-in-chief and co-founder of myStockOptions.com.
The look-back provision bases the purchase price of the shares on the value at the beginning or end of the offering period, whichever is lower. For example, suppose your ESPP offers a 15% discount and lookback. With an opening price of $20 and a final price of 22, you get 15% off $20 for a savings of 22.7% per share.
According to Report for 2022 by Morgan Stanley at Work.
What you need to know before selling shares
While it may be tempting to cash in your shares at a discount, they are complex taxation rules consider including discount fees. The breakdown of regular income and more profitable long-term capital gains depends on when you sell.
Your employer may also require you to hold the shares for a certain period of time. “Some companies have an additional holding period requirement,” Brumberg said. “They don’t want you to flip stocks.”
The gold standard for the plan would be 15% off with a review feature.
Bruce Brumberg
Editor-in-chief and co-founder of myStockOptions.com
Of course, there are other important details that need to be confirmed in the planning document.
You’ll want to know if an ESPP is taxable, what it can save, how to sign up, the length of the offer period, purchase dates, how to make changes and what happens if you leave the plan, he said.
Before ESPP, check all the other boxes
​​​​​​While a down market may offer an even greater discount, allowing you to buy more shares, there are other trade-offs to consider before doing so.
There’s no guarantee you’ll make a profit because “stocks don’t always go up,” McKenna said.
Indeed, most individual stocks do not outperform the market, according to a Analysis by JP Morgan. From 1980 to 2020, almost 45% of companies with Russell 3000 Index suffered a 70% price drop from its peak and never recovered, the report shows.
Given these risks, experts may recommend ESPPs as a supplement to your 401(k) rather than as your primary way to save and invest. And you’ll still want to weigh your risk tolerance and goals before signing up.
It may be worth considering an ESPP if you’re already reaching your other financial goals, such as maxing out your 401(k), investing in a brokerage account, paying off debt or other savings goals, McKenna said.
It might work if you “check all the other boxes,” she said, but it might be better to focus on other planning opportunities first.
