Whether you've participated in an Employee Stock Purchase Plan (ESPP) for years or want to become a part of one soon, it helps to know the key terms surrounding ESPPs. The terms below will broaden your understanding of employee stock purchase plans and serve as a helpful tool for those learning about ESPPs. From contribution limit to qualifying disposition to lookback provision, here are 15 key terms you need to know about ESPPs — no matter your experience with them.
ESPP
An ESPP — or Employee Stock Purchase Plan — is a valuable stock benefit that some publicly traded companies offer their employees. ESPPs allow employees like yourself to buy shares in your employer's company at a significant discount. This discount typically ranges from 5% to 15% of the stock's fair market value.
With the simplest ESPPs, money is taken from your paycheck and placed directly into the ESPP. Then, your company uses that money at pre-set intervals to purchase shares on your behalf. Your purchased shares are then placed into your employee investment account.
Contribution Limit
An ESPP contribution limit is the maximum amount of money you can use to purchase discounted shares. Most ESPPs tend to have a contribution limit of $25,000. What's more, this contribution limit is based on the stock's pre-discount price. For instance, if your ESPP offers a 15% discount, your contribution limit will be $21,250 for that annual period.
Enrollment Period
An enrollment period is the limited window you have to sign up for your company's ESPP. Deadlines and start dates vary from company to company, so if you miss an enrollment deadline, you'll have to wait until the next one. Depending on your company's enrollment period, this could mean a wait time of anywhere from six to 24 months.
Offering Period
While some companies use the terms enrollment period and offering period interchangeably, others clearly distinguish between the two. When this is the case, an offering period is the window when money is deducted from your paycheck. Offering periods tend to come in intervals of six months and can stretch as long as 12 to 24 months or more.
Most companies tend to purchase shares every six months within the offering period. For example: If your company's offering period is 12 months, they might purchase stock on the first Monday of January and the first Monday of July.
Qualifying Disposition
A qualifying disposition in an ESPP refers to the purchase, sale, or transfer of eligible stock. In an ESPP, qualifying dispositions need shareholders' approval before official implementation. Additionally, all members of the ESPP are entitled to equal benefits within the qualifying disposition. In other words, no one person can get a better or worse discount.
Disqualifying Disposition
A disqualifying disposition is a term used to describe stock sold outside the terms of the qualifying disposition. Typically, this would be before the second anniversary of the offering date or within a year of the date purchased.
A disqualifying disposition results in your company reporting the amount earned from your percent discount on the stock as income on your W-2. You will then have to pay taxes on it as if it was your ordinary income.
Deferred Compensation
You might hear ESPPs referred to as "deferred compensation." This term describes any additional income put away for a future payout, including an ESPP, a retirement plan, a pension, and the like. Taxes are what's being deferred — typically, you won't be taxed for deferred compensation until you receive those funds.
Rising Share Price
In the stock market, a rising share price is when the amount you must pay for one share of a company's stock increases. A rising share price will occur if more people buy a stock than sell it. The more a share price rises, the more valuable your shares in that stock will become.
Falling Share Price
Conversely, a falling share price occurs when the amount you must pay for a single share of company stock decreases. A falling share price happens when more people sell said stock than purchase it. Likewise, the more a falling share price decreases, the less valuable your shares in that stock become.
Quick Sale
Your company's ESPP may offer a Quick Sale program. In the case of a quick sale, you can immediately sell your purchased discount shares at their fair market value. Referred to as "flipping" in some circles, it means you will profit exclusively from the discounted 5-15% without enjoying the long-term appreciation of investing.
Grant Date
The grant date is the first day of your ESPP's offering period, and it will be made known to you in your company's ESPP terms and conditions. You might also see the grant date referred to as the offering date.
Purchase Period
The purchase period is the pre-determined time frame when your company accumulates your payroll deductions for a discounted stock purchase. There will typically be one or more purchase periods within a single ESPP offering period. For example: if your ESPP's offering period is 12 months, you might have a purchase period between January 1 and July 1 and another between July 1 and January 1.
Purchase Date
An ESPP purchase date is the pre-set date when shares in your company's stock will be purchased. Purchase dates tend to fall at the end of every purchase period and offering period. You'll be notified of your ESPP's purchase date(s) prior to enrolling.
Discount
When speaking about ESPPs, the word "discount" refers to the amount of money subtracted from the fair market value of your company's stock. Depending on your company's particular terms, the discount might range from 5% to 15% or more.
The discount is the main appeal of an ESPP, as it essentially gives you the ability to purchase stock in your company at a lower price than those outside the company. If your company's stock has a fair market value of $20 a share, and your ESPP's discount is 10%, you'll be purchasing your company's stock at a discounted price of $18 a share.
Lookback Provision
An ESPP's lookback provision (or lookback period) locks in your company's price per share exactly where it was on the grant date. Then, if your company's stock price drops or rises between the grant date and the purchase date, the lookback period will give you whichever discounted price is lower.
If you have an ESPP with a lookback provision or lookback period, you're guaranteed to make a profit regardless of whether your company's share price rises or falls between the grant date and purchase date. This provision offers a considerable advantage over simply receiving stock options.
Purchase Price
The purchase price is the total amount you pay for discounted shares on your ESPP's purchase date. The purchase price will differ from your company's price per share at fair market value, especially if your ESPP has a lookback provision.
Think of it like this: Your company's stock has a fair market value of $15 per share on the grant date. By the actual purchase date, the price per share increases to $20. The lookback provision combined with your ESPP discount (let's say it's 15%) will give you a purchase price of $12.75 — $7.25 less than the fair market value.
Questions About ESPPs?
If you still have questions about a new or existing purchase plan, consider reaching out to a financial advisor. Plancorp's elite team of evidence-based investors specializes in asset and wealth management, guiding clients on matching investments to their goals and lifelong financial plans.
In addition to wealth management and financial advising, other Plancorp services include tax strategy, estate management, insurance guidance, compensation, and much more. Contact Plancorp today to get started.
