Employee Stock Purchase Plans (ESPP) for Beginners: Should I Start?

Hello, everyone! I'm Khumbo from Road to Wealth, and today, we're diving into the world of Employee Stock Purchase Plans (ESPPs). If your company has mentioned ESPP benefits or you've received emails nudging you to enroll, you're in the right place. Let's demystify the ESPP together and help you determine if it's the right move for you.

Understanding Employee Stock Purchase Plans

An Employee Stock Purchase Plan (ESPP) is a program that allows employees to purchase company stock at a discounted price. Here's a quick rundown:

• Discounted Stock Purchase: Employees contribute through payroll deductions over a period, usually 6 to 12 months, building until the purchase date.

• Discount Rate: The discount can be as much as 15% of the closing price of the shares, offering a significant benefit.

Primarily used in American companies, ESPPs are an additional employee benefit. Before we proceed, let's establish some key definitions and important dates:

• Offering or Enrollment Date: Deadline for opting into the program, marking the beginning of the offering period.

• Exercise or Purchase Date: When the company purchases shares on behalf of employees, concluding one period of contributions.

• Offering Period: Typically 24 months from the offering date, during which employees contribute money monthly.

Now, let's explore how ESPPs work.

How ESPPs Work

If you enroll in your company's ESPP, your contributions begin from the offering date. For instance, if your offering date is on the 1st of April and you contribute for 6 months, your purchase date would be on the 30th of September. The company then determines the lower of the stock price on your offering date or purchase date, applying a discount (usually 15%) to determine your purchase price.

Stay on the plan, keep contributing, and your purchase price remains fixed for the entire offering period, which is typically 2 years. Now, let's address the timeline for reaping the rewards.

Reaping the Rewards

You can sell the shares immediately after the purchase date, subject to regular price fluctuations. But, as with any investment, there are risks to consider.

Risks of ESPPs

While the benefits are evident, here are a few risks:

• Share Price Fluctuations: If the share price on the purchase date is lower than the offering date, your new purchase price is adjusted accordingly.

• Decision to Pull Out: Post-purchase date, risks align with general stock market fluctuations. You may choose to keep or sell your shares, impacting your risk and diversification.

Tax Implications

ESPP taxation rules are complex. Qualifying dispositions are taxed during the stock sale year, with the discount taxed as ordinary income. Unqualified dispositions may result in ordinary income tax rates being applied to the entire gain.

Transferring Back and an Example with Google

For a clearer perspective, consider the example of Google, where a 15% discount on the purchase price can be a significant advantage. Immediate selling can result in a gain, but taxes apply to the discounted amount.

My Approach to ESPPs

Personally, I've chosen to maximize my ESPP because immediate selling guarantees a return, irrespective of market fluctuations. Even after my first purchase post-March crash, I've experienced impressive returns.

In conclusion, ESPPs can be a valuable addition to your financial strategy, but it's crucial to weigh the risks and understand the tax implications. Remember, financial decisions should align with your individual goals and risk tolerance.

Feel free to share your thoughts and experiences with ESPPs in the comments below!