Understanding Employee Stock Purchase Plans

By Michael Diaz. May 7th 2016

Does your company have an employee stock purchase plan? If so, you may want to think about enrolling in the plan. Employee stock purchase plans are a great way to invest in the company that you work for. They can also help you to grow your wealth for retirement. However, before you enroll, you need to get up to speed on what an employee stock purchase plan is and what the benefits and drawbacks of these plans are.

What Is An Employee Stock Purchase Plan?

An employee stock purchase plan (ESPP) is a stock purchase plan that employers set up to allow their employees to easily purchase company stock through payroll deductions. The purpose of these programs is to allow employees to share in the success of the company that they work for. This helps to align the interests of the employees and the interests of the company shareholders. In order to encourage employee participation, many employers offer company stock at a discounted price.

How Do Employee Stock Purchase Plans Work?

Generally, employees can enroll in their company’s ESPP during a specified enrollment period. If your company has an ESPP, it will inform you when the enrollment period is so that you can enroll in the plan if you are interested.

If you decide to sign up for the program, you will need to decide how much money you want your company to take out of your paycheck to buy company stock. You will likely have to choose a percent to take out of each paycheck or a fixed dollar amount to take out of each paycheck. Most ESPP’s have a limit on how much income employees can contribute to the plan. However, the actual limit will vary by plan. Keep in mind that Uncle Sam limits the total annual amount anyone can contribute to an ESPP to $25,000.

Once the enrollment period ends, an offering period begins during which your company will start collecting your payroll deductions and putting them into an account with your name on it. At the end of the offering period on what is called the purchase date, your company will use the money from your payroll deductions to purchase shares of your company. The shares will then be deposited into your brokerage account and any money leftover will be put back into your ESPP account to use on the next purchase date.

Many plans allow the enrolled employees to increase or decrease their payroll deduction percentage or fixed amount during the offering period. On the other hand, some companies have small windows when such changes can be made. Generally, you can stop the payroll deductions at any time. However, some plans only allow you to stop deductions during specified dates. The bottom line is that you need to fully understand how your EESP works before enrolling.

There Is Usually A Stock Price Discount

Most ESPPs give employees a discount on the price of the company stock. However, how this discount works varies from plan to plan. For example, some plans will take a haircut on the market price of the stock on the purchase date. Other ESPPs take the lower of the share price on the first or last day of the offering period and apply the discount to that price. If your company offers a discounted price on its ESPP, make sure you understand how it works.

The Benefits Of ESPPs

  • Convenience: If you want to invest in your company, an ESPP will give you an easy way to accomplish this goal. The automatic payroll deductions and stock purchases mean that you do not have to do anything after you have decided how much you want your company to pull out of each paycheck.
  • Stock Price Discount: As stated above, most ESPPs allow employees to purchase company stock at a discount. If you sell your shares immediately after receiving them, you will likely be able to make money by taking advantage of the difference between the price you paid for the stock and the current market price. Note that this profit is not guaranteed given the market price of the share can fall drastically at any time.

The Drawbacks Of ESPPs

  • Investing In Stocks Are Risky: Given the volatility of the stock market, investing in any stock is risky. If the stock price of your company falls significantly after you purchase the stock, you could lose money if you sell the shares.
  • Concentration Risk: Have you ever heard the saying “don’t put all of your eggs in one basket?” In the world of personal finance, this means that you should never have too much of your money tied to one source. Since you already get a lot of your money from your job through your wages, some financial advisers believe that investing in company stock is putting too much of your money in the hands of your company. If your company goes bust, you will lose your salary and you could also lose the money you invested in the company stock.

ESPPs can offer you a great opportunity to invest in the company that you work for. However, you should do your homework before signing up for your company’s plan. Make sure you understand all the ins and outs before putting a significant amount of your money into company stock.

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