How Much Money Should You Contribute To Your ESPP?

Equity Compensation | Employee Stock Purchase Plans

 Derek Jess By: Derek Jess

Employee stock purchase plans are a great benefit that many companies offer to help employees invest in the future of the company and make more money. When managed properly with tax implications in mind, your ESPP shares can be turned into rocket fuel for your financial goals.

If you’ve landed on this article, you’re likely preparing to enroll in your company’s ESPP, but you’re not sure how much money you should be contributing.

Read on for common situations that may help you narrow down a figure.

What is an ESPP?

An ESPP is a favorable benefit that companies offer employees as a way of investing in the future of the business.

It allows an employee to purchase company stocks at a discounted price of up to 15% of the stock price on the purchase date. It is one of four types of equity compensation employers commonly offer.

Helpful ESPP Definitions

Offering Date / Grant Date: The first day you can begin making contributions to an ESPP via payroll deductions.

Purchase Date: The date when company stock is purchased. This date starts the clock for qualifying dispositions and long-term capital gain treatment.

Purchase Period: The time between the offering date and the purchase date where contributions via payroll deductions accumulate.

Purchase Price: The actual price an employee pays for their stock shares after the discount.

Lookback Provision: If offered, the discount rate will apply to the stock price on the offering date or the purchase date, whichever is lower.

Qualifying Disposition: Occurs when you sell stock more than 24 months after the offering date, and more than 12 months after the shares were purchased.

Fair Market Value: The estimated current value of stock shares

How Does an ESPP Work?

Once enrolled in your employee stock purchase plan, you can make contributions through regular payroll deductions, during what is referred to as an offering period.

After a period of typically six months, the employer uses that money to purchase company stock on behalf of the employee. This is referred to as the purchase date. The employee then retains ownership of the purchased shares until they decide it is beneficial to sell—usually decided by tax treatment and capital gains.

There are several things to consider when thinking about selling your ESPP stock, like whether you’ve achieved a qualifying disposition, the value of the stock, your capital gains and losses, and potential tax advantages. We recommend reading this article which outlines helpful strategies for a successful employee stock purchase plan.

But before you get too in the weeds of how employee stock purchase plans work, you need to decide the basics: How much should you contribute? When it comes to taking that money out of your paycheck, there are several factors to consider.

How Much Money Should I Contribute to My ESPP?

Even before enrolling into an ESPP, there are two big components to take into account: your personal finances and the benefits your employer offers.

Analyze your personal finance situation: Before you set up any contributions, take a look at your overall financial plan. Determining your current net worth is a great start.

To do so, examine all of your bank accounts, investments, and other assets. Compare that to any outstanding debt you may have like credit cards, auto loans, and student loans. Use this worksheet to get started.

Analyze your employer benefits: What other benefits, like retirement plans and matches, does your employer offer? Is there a 401(k) and do they offer a match? If money is already coming out of your paycheck to go toward a 401(k), this may affect how much you contribute to an ESPP.

What is the ESPP stock discount? Is there a lookback period? These are helpful questions to answer to determine just how much value there is to be gained through participating in your employee stock purchase plan.

Below are several scenarios that may fit your current situation. Use these as a guide when determining your ESPP contribution amount.

If you have credit card debt...

Before you contribute anything to an ESPP, you should pay off — or at the very least, pay down — your credit card debt. Interest on credit cards builds up quickly, washing out anything you earn from your ESPP.

If you have other types of loans...

Your goal should be to pay off student loans or car loans as quickly as possible, but because these types of loans typically have smaller interest rates (between 2% and 6%), it’s safe to also put a percentage of your paycheck toward your ESPP if you’re able to get a discounted price on your purchased shares that’s greater than the interest rate of your loans.

If you sell your stocks immediately after purchase, you’ll have money to put toward paying off those loans. Make sure you’re contributing up to the company-match percentage for your 401(k), and then choose a percentage that feels comfortable to you for your ESPP contribution.

If you have small debt/no debt and little savings…

Your priority should first be to set aside enough money in a savings account to cover three to six months worth of expenses in case of an emergency. After you’ve saved up that nest egg, this option is similar to the one above. 

As long as you have enough money in your savings account, invest as much as you can into your ESPP while still managing to pay the bills, of course. Once you’re able to sell, you can obviously decide what to do with that money, but we’d recommend building your nest egg. 

If you have savings and no debt but money is tight…

Even if you don’t have debt and have a comfortable cushion in your savings account, it’s understandable that money can still be tight. Inflation rates have been astronomical lately.

If this is your situation, make sure you contribute up to the employer match for your retirement plans, and then determine an ESPP contribution that is comfortable for you based on your cash flow

Determine your cash flow using this free worksheet .

If you no debt and excess cash flow..

If you have no debt, you’re contributing up to the company match in your 401(k) PLUS saving money, you should do what you can to max out contributions to both your 401(k) plans and your ESPP. This will result in you substantially growing your net worth.

The IRS has a 401(k) contribution level set at a max of $23,000 for 2024 (plus a $7,500 catch-up contribution if you are at least age 50) and an ESPP contribution limit at $25,000 per calendar year.

For more strategies on setting up a successful ESPP, click here.

Investing in an ESPP

It’s easy to get excited about investing in the future of your company, but be careful not to do so hastily. Consider your net worth and work from there to determine an amount that fits your lifestyle and budget. 

ESPP plans are a great benefit that can put extra cash in your pocket. But from a tax perspective, ESPP shares are perhaps one of the most complicated types of equity stock options you can own. Consulting with a financial advisor is one of the smartest things you can do when making decisions about ESPPs and any other types of equity compensation.

If you’d like some additional support in figuring out how much to contribute or when the right time to sell ESPP shares is, our experienced team of Plancorp advisors can help. We are committed to helping make your equity compensation a key driver of success for your overall financial plan.

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Derek joined Plancorp in 2018 after spending the previous three years of his career as a financial advisor in Boulder, Colorado. As a CERTIFIED FINANCIAL PLANNER™ professional, he is passionate about helping people make financial decisions tailored to the life they want to live. More »