Overview of Employee Stock Purchase Plans (ESPPs)


By Kaye A. Thomas
Updated June 20, 2010

A good way to acquire stock in your company.

Employee stock purchase plans can be a good deal for those who participate. Like incentive stock options, they can make it possible for you to buy stock at a bargain price without reporting income until you sell the stock. In some ways they're even better than ISOs:

  • A qualified ESPP can provide you with a discount: the purchase price of the stock can be as much as 15% below the value of the stock at the time the price is established.
  • You don't have to deal with alternative minimum tax (AMT) when you buy shares under an ESPP.

Incentive stock options can be better in other ways, though:

  • They can be for a larger dollar amount, and offer a longer purchase period.
  • They offer a way to convert all your profit to long-term capital gain if you hold shares long enough. When you use an ESPP to buy shares, part of your profit can be ordinary income even if you hold the shares many years.

Typical terms

A qualified ESPP can offer stock options that are similar to incentive stock options, but few companies set them up that way. Instead, they offer an opportunity to buy stock at a favorable price through payroll deduction. In a sense you're exercising an option if you choose to participate, but it isn't quite the same as holding a stock option. The specifics of these plans vary from one company to the next. Keeping in mind that your company's plan could be different, here are some typical terms:

  • If you want to participate, you have to sign up by a particular date to have from 1% to 10% of your pay withheld to purchase company stock over a particular offering period.
  • Money withheld from your paycheck will accumulate for that period of time, and then be used to buy stock at the end of the offering period. The price may be discounted as much as 15%, although companies can offer a smaller discount or none at all.
  • Some companies provide a "lookback," so that the price you pay can be based on the price at the beginning of the offering period or at the end, whichever is lower. With this type of plan, if the price goes up during the offering period you get an extra bargain, just like when you hold a stock option. 
  • Usually you can back out of the purchase and get your money back at any time until close to the end of the offering period. Your last chance to withdraw may be a week or two before the end, though, so check this deadline.

How you benefit

You can benefit from an ESPP in several ways. It's a way of saving and investing with money that automatically comes out of your paycheck, which is an excellent way to build wealth. If the company provides a discount, your savings get a boost. On average you would expect to wait close to two years to see a stock investment grow from $85 to $100, so that discount is a big head start. If your company's plan offers a lookback, so you can buy based on the price on the offering date even if the stock is trading at a higher price on the purchase date, you can really turbocharge your savings.

Apart from the financial benefits, there's something special about having a stake in your company's fortunes. It's one thing to watch an investment grow in value, and quite another to participate in the rewards of a success you helped create. Holding stock in the company where you work can provide a kind of satisfaction you can't get from other investments.