If you have the option of participating in your workplace Employee Stock Purchase Plan (ESPP), you’ll want to become familiar with these terms and rules. For an introduction to the basics of ESPPs, see this blog post.

Purchase Period 

This is the period of time during which your employer will set money aside (after-tax) to purchase company shares. For example, if your purchase period is 6 months, your employer will set money aside from every paycheck for 6 months (amount is based on your chosen percentage). At the end of the 6 month period, your employer will purchase shares with the balance in your account. 

Look Back Provision 

This provision bases the purchase price of the shares on one of two time periods: 

1. The price at the beginning of the purchase period 
2. The price at the end of the purchase period 

The price used is the lower of the two prices above. For example: if the stock price appreciates over the 6-month purchase period from $80 per share (6 months ago; beginning of purchase period) to $100 per share (today; end of purchase period), then the plan would purchase shares for $80. You could then immediately sell your shares and realize a $20 profit without incurring any market risk (stock price fluctuations)  

Price Discount 

This provision would allow the plan to purchase shares at a discount to market value. For example, if the plan has a 15% discount, and the market price at the end of the purchase period is $100 per share, the plan would purchase shares in your account for $85. If the plan also includes a lookback provision (as in the previous example above) the 15% discount would apply to the lower price at the beginning of the offering period ($80). In this case, the plan would purchase shares at $68 per share (15% discount to $80). 

ESPP plans with lookback provisions and price discounts can be a very valuable piece of your financial plan. 

$25,000 IRS Annual Maximum 

Tax rules for tax-qualified 423 employee stock purchase plans (ESPP) limit purchases to $25,000 in each calendar year. The $25,000 is calculated based on the market price at the start of the offering period on the undiscounted share price at that time.

For example, if the stock price drops from $20 at the beginning of the period to $10 at the end of the period, you can only buy a maximum of 1250 shares ($25,000 / $20).

Company-Imposed Maximum 

Companies can impose their own maximum contribution rules to an ESPP (e.g. 10% of salary).

You’ll need to become familiar with the plan document (not exciting… I know). 

Company-Imposed Holding Period 

A common strategy with an ESPP that includes lookback and discount provisions is to sell shares immediately after the plan purchases shares. If sold immediately, you receive a riskless return. However, some companies require holding the stock for a specific period of time after purchase (e.g. 6 months). This would make ESPP participation less appealing, since you are now required to hold (take on market risk and price fluctuations of the stock). 

Every ESPP will have its own rules and restrictions. .You’ll need to set some time aside to read the plan document (exciting, I know) in order to familiarize yourself with the details. ESPPs can be an incredibly valuable tool in your overall financial plan. Speak with a professional if you have specific questions.