What Is an ESPP and How Does It Work?

What is ESPP? Many employees can not fully benefit from an employee stock purchase plan, as they do not know the answer to this question. An employee stock purchase plan (ESPP) can give solid returns. In the following, we will discuss what is ESPP and how does it work.

What is ESPP?

An employee stock purchase plan is a type of benefit that allows you to buy the shares of the company you work for for a discount, typically, between 5-15% off the actual market value. For instance, if the fair market value is $10 per share, and you got a 15% discount on your plan, you can buy those shares for$8.50 per share.

Only publicly traded companies offer ESPP. However, not all public companies offer employees to participate in an employee stock purchase plan.

How Does ESPP Work?

At first, you need to decide on what percentage of your paycheck you want withheld to buy your company stock at a discount. Keep in mind that the IRS currently limits you a max contribution of $25,000 per year towards an ESPP. However, your employer can cap your contributions at a lower amount or a percentage of your income.

Note: There is a difference between Roth 401(k) plan and ESPP, ESPP contributions are withheld from after-tax income.

Let’s see another example, you enrol the plan before the start of the new year deciding a 10% contribution towards the ESPP. Throughout the duration of the offering period, your net pay will be 10% lower. On July 1st, the money withheld from your paychecks will be used to buy stock in the company on your behalf.

In addition, there is one more appealing thing about the plan is a “look back” provision. A look back provision typically allows you to use whatever discount your company offers to the lower of two numbers: the price on the first day of the offering period or the price on the last day of the purchase period. Even if a 15% discount is appealing on its own, the opportunity to apply it to a minimum of two prices makes ESPPs even more appealing.

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