As an employee of a publicly traded company, you may have the opportunity to participate in an Employee Stock Purchase Plan (ESPP), which could lead to valuable discounts on company shares. However, before jumping into your organization’s ESPP program, it is crucial to understand its rules and potential risks according to financial experts.
According to a recent survey by The National Association of Stock Plan Professionals and Deloitte Tax, roughly half of public companies offered an ESPP in 2020. Matthew Garasic, certified financial planner from Unrivaled Wealth Management in Pittsburgh, explains that these programs can be beneficial because they offer “free money” to employees.
However, before participating, you need to consider your short-term priorities and how comfortable you are with sacrificing cash flow during the offering period. Kristin McKenna, president of Darrow Wealth Management in Boston adds that yearly goals such as contributing up to an employer’s 401(k) match should take precedence over ESPPs if your income is limited.
During a six-month offering cycle known as the “offering period,” participating employees have after-tax contributions withdrawn from their paycheck, which are used to buy discounted company shares at a specific date in tax-qualified plans with an annual limit of $25,000. The best ESPPs offer 15% discounts and include what’s known as the “lookback provision,” where stock purchase prices are based on values from either the beginning or end of offering periods – whichever is lower.
The immediate gains obtained by selling shares quickly after purchasing can be significant, but participants will owe regular income taxes plus levies for any gain achieved during the offer period’s course. The future price performance remains uncertain, however; it could lead to losses if stock prices do not cooperate over time.
According to recent reports from NASPP, most tax-qualifying ESPPs provided 15% discounts in 2023 compared with 70% of such programs offered in 2020. The percentage of plans offering lookbacks has also increased significantly during this period (from approximately 64 % to almost 83 %). Nevertheless, prospective participants should carefully read the plan documents before opting-in as they contain essential details about qualifying ESPPs’ tax treatment, lengthy offer periods, purchase dates, change procedures and what happens if an employee leaves.
McKenna warns that these rules can be overly complicated but acknowledges their potential benefits for some employees. She advises individuals to weigh the costs against other priorities before making a decision about participating in ESPPs offered by public companies.
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