The Minimal Investor ESPP Guide and Calculator

I’ll be honest, I’d never heard the term ESPP or “employee stock purchase plan” up until recently. As soon as the company I work for announced they were starting one, I began consuming everything I possibly could about them. Are they worth it? Why should I use one? What’s in it for me?

If you’re completely new to the topic and trying to wrap your head around it, then this guide is for you. I’ve been going through the same road to discovery on this issue and wanted to write up a guide about what I’ve learned while everything is still fresh in my mind.

If anything you want to know about employee stock purchase plans isn’t covered in this guide, feel free to ask in the comments! This is a living document of the most common questions asked. If you’re unsure if you should ask – please ask. If you have a question then chances are many others also have that same one.

What is an ESPP?

An ESPP, or employee stock purchase plan, is a company-run program (like a 401k) that allows employees to buy stock, often at a discount. ESPPs are often offered a benefit/incentive at publicly traded companies, allowing employees to earn more money than they could with their paycheck alone.

You might be thinking the same thing I was:

Why would I want to buy stock at my company? Shouldn’t I just invest in diversified index funds?

If the choice was investing in the company or not, that would be true. But by being an employee and participating in an ESPP, there are potentially some huge benefits! There are two huge ones are:

• Discount Price – ESPPs generally offer participants a discount on the price of the stock. The SEC limit for this discount is 15%.
• “Look-back” period – Some ESPPs offer a “look back” price with a certain timespan – at most 3 years. Rather than purchasing the stock at today’s price, you will “look back” over this time span and get the lowest price amongst all past purchase and offer dates for your ESPP.

In other words, the “best possible” ESPP would have a 15% discount and a 3-year look back.

How Does an ESPP Work?

Here’s an example. The company defines an “offering period“. This would have a beginning and an ending date. We’ll use Home Depot as an example since they’re a public company with their ESPP details on file with the SEC. We’ll use a few terms here, so I’ll define them ahead of time.

• Offering date. The beginning of the offering period. The first date at which you’re able to contribute to an ESPP. (May 1, 2017 in this example).
• Offering period. The time range during which money is set aside from your paycheck for the ESPP. (May 1, 2017 – November 1, 2017 in this example).
• Purchase Date. The date at which stock is actually purchased. (November 1, 2017 for this one)

Let’s go back in time and assume the offering date was May 1, 2017 and the purchase date was November 1, 2017 (6 months later). This would mean that within the company, they offered the capability to join the ESPP to all eligible employees in the weeks before May 1, 2017.

Chances are that in April, they started sending out a lot of company emails, held training sessions and did their best to help employees understand what an ESPP is and how it would be beneficial.

After May 1, 2017, no one new can join for that offering period. On 5/1/2017, Home Depot’s stock price was $154.95. Keep that number in mind.

Home Depot’s plan isn’t bad. They offer a 15% discount price, with a $25,000 yearly maximum and a 6-month look back. That $25,000 yearly maximum means that in a 6-month period, participants can contribute as much as $12,500 to the ESPP. This is contributed through payroll deductions, and cannot be directly bought with cash.

Let’s say we max it out and put $12,500 into the ESPP. What that means is that for the 6 month period from 5/1/2017 to 11/1/2017, our paychecks will be smaller. If Home Depot issues paychecks out twice a month, that’s 12 paychecks, each roughly $1,041.66 less than usual. This money will be after tax.

So what happens on November 1, 2017? Home Depot has a 6-month look back. That means that they look at the price on 5/1/2017 and the price on 11/1/2017 and you get to purchase at whichever one is lower. The price on 11/1/2017 was $165.38, so you would get to purchase based on the 5/1 price of $154.95.

What about the price between May 1st and November 1st? For the ESPP those dates won’t matter. The price could have risen to $200 or dropped to $100 – it won’t matter. The “look back” price will only take into account the price at the “start date” and any “purchase dates”.

But, it gets better. Instead of purchasing at $154.95, you’re able to purchase with a 15% discount. This means that you’ll effectively pay $131.70 a share! Considering it’s worth $165.38 at the time you purchase it for, that’s quite a deal!  That’s a lot of variables, so let’s look at them all in one place.

Even on this period, if you joined the ESPP, you’d have made a 19.7% return on your investment after-taxes. Before taxes, it’s over 25%!

When Should I Sell My ESPP Stock?

The above example is assuming you sell your stock immediately on the date you get it – which is the most common thing people do. It’s your safest bet, and as close to a sure thing as you can get in the investing world.

This is called a “same day sale”, something you would elect to do in the weeks prior to the purchase date (November 1st in this example). Your purchaser would then buy the stock for you and sell it automatically, and you would (most likely) receive the proceeds from the sale in your bank account just like a paycheck.

There is a small chance of this going poorly. The time between when the stock is bought and when it’s sold could be a day, or even two days. If the value of the stock drops by more than your discount price during that time, you will lose money on this deal. It’s highly unlikely, but it’s not impossible.

How Do Taxes Work?

Tax rules for ESPPs are weird. If you do a same-day sale, you’ll pay ordinary income tax on the gains between your discount price and the current stock price at whatever your current tax rate is.

In the above table, the “Estimated Taxes” is based on a 22% tax rate on the $3,165.92 profit. 

Depending on how your company handles taxes, they may sell some of the shares to pay these taxes for you. From what I’ve read, most companies will pay the taxes for you out of your shares. Keep in mind that the trade is taxable income in case they don’t.

The other option is to hold onto the stock long-term. With that, there is a somewhat odd scenario for taxes that initially confused me. Bear with me here with an example:

• On 11/1/2017 you buy $12,500 of stock at $131.70 and decide to hold onto it for a year.
• On 11/1/2017, you immediately need to pay taxes on the difference between $131.70 and $165.38. This is the same tax you’d pay if you sold immediately – roughly $696.50. Your employer may sell some of the shares immediately to cover this tax. In this case, let’s say they sold 5 shares and paid all taxes.
• One year later on 11/1/2018, you sell your remaining 89 shares (94 minus the 5 for taxes) for $200 a share. You’ll likely pay capital gains tax of 15% on this, with your tax-basis being $165.38 for each share.
• You effectively bought the 89 shares for $14,718.82 (89 * $165.38) and sold them for $17,800, for a total profit of $3,081.18. You’d likely pay $462.177 in capital gains taxes and take home $2,619.00.

Even though the price went up almost 25% in the year that followed, your gains increased by $3,081.18 on top of the original $2,619 by holding onto the stock long term. That $3,081.18 would be taxed at your capital gains rate, which would be lower. In addition, you added a lot of risks – including the risk the stock went down and you lost money. That’s why the most common advice is to do a same-day sale.

To recap, if you sell your shares immediately, they’ll be taxed at your ordinary income tax rate – the same rate used for short-term capital gains. The IRS will lower this to your long-term capital gains rate if you hold the shares for at least 1 year from when you can first sell your shares. During that time the stock can go down though, so it’s a risk.

What if the Stock Goes Down in Price?

Between the “Offering Date” and the “Purchase Date”, the stock could go up, down or stay level. In the Home Depot example above, it went up a good amount, but what if it had gone down to $100?

Luckily it wouldn’t have been bad news for ESPP holders. When the “Purchase Date” came around (11/1/2017 in our example above), we’d look at the two prices: $154.95 on 5/1/2017 and our (fictional) $100.00 price on 11/1/2017.  You would get the lower of those two.

This means that you would get to purchase the stock at 15% off $100, or $85 a share for a total of 147 shares (spending $12,495).

If you were to sell those 147 shares immediately at $100 each, you’d make $14,700, or $2,205 in revenue. After taxes, that’s still roughly $1,719.90, which works out to a 13.7% return on your initial investment of $12,495.

Even if the stock drops, you can make a large return on your investment with an ESPP.

That’s the key of all this to me. Since you’re getting the lower of two numbers and a discount on top of that, the math should work out to make you some money.

How Much Should I Contribute To My ESPP?

That depends. If your ESPP doesn’t offer a discount price the math on an ESPP isn’t quite so black and white. A diversified portfolio generally returns somewhere between 7%-9% a year. That’s the benchmark I measure any ESPP gains against. If you can get more than that from your ESPP in the worst case scenario, I think you should max it out and thank your finance department for having an awesome plan.

You can use the calculator below to see if the returns for your plan would fall above or below that number. If they’re above it, max it out. If they’re below it or require the stock to jump up for the math to work – it’s up to you. You know more about your companies likely to grow than I would. Just remember that the alternative is to invest in the stock market as a whole and potentially make 7-9%.

What Happens if You Leave the Company?

If you leave the company between the “offer date” and the “purchase date”, then you will have contributed money towards the ESPP but the actual purchase will not have happened. Unfortunately, you need to be an employee at the company on the purchase date for the ESPP purchase to go through.

If you leave before then your last paycheck will include all of the contributions you made to your ESPP in one lump sum. Unfortunately, there is no way around this. You can’t contribute to it in other ways from your savings — it must be funded via payroll deductions.

Who at a Company Can Participate in an ESPP?

This will be different for each company. Typically if you own more than 5% of the companies stock you can’t participate. Some companies limit this by time (1 year+ employees only), hours worked (full time vs part time) or position. Similar to health care, 401ks or other benefits, this one is up to each company to determine who is they want to allow to participate.

How is an ESPP Different from an ESOP?

An ESOP plan, or an Employee Stock Ownership Plan, is completely different than an ESPP. ESOPs are often used to transfer ownership of a business from one owner to the employees.

• ESPPs are usually for public companies, ESOPs tend to be for privately held companies.
• ESPPs have post-tax contributions, ESOPs have pre-tax contributions.
• ESPPs allow participants to get their money soon – often within 6 months, ESOPs participants don’t have access to it until they retire or leave the company.

The last one is the big one. ESOPs area based arounf the idea of company participants as owners. This is why ESOPs tend to be for privately held companies.

How Do I Know If My ESPP is Good?

This question takes a little math and an understanding of what else you could do with your money. US Stock markets as a whole return somewhere between 9-11% a year on average. A diversified portfolio with bonds, US Stocks, and International funds tends to return around 7-8% a year. If your returns from your ESPP are above this, then you’re getting an amazing deal.

There’s nothing in the investing world that is a sure thing, but being able to buy the stock at a discount and sell it immediately for a profit is about as close as you can get. If I had to decide between getting a sure thing 8% and investing in the market to get 8%, I’d take the sure thing all day.

If you’re looking to learn how to invest. I have a great free course on it that will teach you everything you need to know to invest for the rest of your life.

ESPP Returns and Tax Calculator

Below is an interactive ESPP calculator. All underlined values are editable in order to calculate the returns of your employee stock purchase plan. The opinion given at the bottom (with my face next to it) is very general take on the value of your ESPP given the numbers, comparing it to investing in the stock market.

What Companies Offer ESPPs?

I started trying to do research on which companies offer ESPPs, but that led to a long boring night of reading SEC filing.

• Home Depot
• Walmart
• Universal Healthcare
• Fedex
• IBM
• eBay
• accenture
• Amazon
• Apple
• Adobe

What Companies Don’t Offer ESPPs?

• Google

Do you work at a publicly traded company not on this list? Email me at [email protected] and let me know if your company offers an ESPP. I’ll add it to the list!