What Is an ESPP and How Does It Fit Into Your Financial Picture?

If your company offers an Employee Stock Purchase Plan (ESPP), you’re in luck! An ESPP can be a low-risk way to build wealth and take advantage of company growth, often with almost guaranteed returns, if used correctly. Even better, you can set up a system where the profits fund future contributions, allowing your ESPP to run on cruise control without draining your cash flow beyond the initial investment. That said, there are some things to consider before jumping in. In this post, we’ll walk through what an ESPP is, how it works, and tips for getting the most out of it.

What Is an ESPP?

An Employee Stock Purchase Plan (ESPP) allows you to buy company stock at a discount, typically between 5% to 15%, using after-tax payroll deductions. This type of plan offers employees a way to grow their savings by investing in their own company, with the potential for returns over time.

Here’s how it generally works:

1. Enrollment Period:
   You choose how much of your paycheck to allocate toward buying stock, typically up to a certain limit (e.g., 10%-15% of your salary). There’s also an annual cap—$25,000 in 2025—on the total value of shares you can buy through the plan.
2. Offering Period:
   During this window (usually six months or more), your ESPP contributions are withheld from your paycheck and held in a separate account.
3. Purchase Date:
   At the end of the offering period, your saved contributions are used to buy company stock at a discount.‍

Bonus Feature: Some ESPPs offer a lookback provision, meaning the discount applies to the lower of the stock price at the start or end of the offering period. If your company’s stock price rises during this time, this feature can boost your returns significantly.

The Benefits of an ESPP

The most obvious advantage of an ESPP is the ability to buy company stock at a discount. That immediate discount gives you an edge right from the start, allowing your money to potentially grow faster than if you invested elsewhere.

This benefit can be magnified with a lookback provision. For example, let’s say that your ESPP does have a lookback provision, offers a 15% discount, and the stock price is $10 at the start of the offering period.

If the stock price falls to $5 by the end of the offering period, you’ll be able to purchase it for $4.25 per share (a 15% discount on the current $5 price). This is a great deal that gives you an immediate 15% return on investment.

But if the stock price rises to $20, you’ll be able to purchase it for $8.50 per share (a 15% discount on the original $10 price). That equates to a 57.5% return on investment, which means you’ve just recognized a huge gain!

Not all ESPPs work the same way, so you’ll have to read through your plan documentation to get the details on your specific plan.

How is an ESPP taxed?

How your ESPP proceeds are taxed depends on when you sell your shares.

If you sell them within one year of the purchase, the amount attributable to the discount will be considered ordinary income and taxed at your regular income tax rate, and any gains will be considered short-term capital gain and also taxed at your regular income rate.

If you hold your shares for at least one year after the purchase date (and two years after the offering date), the discount will still count as ordinary income but any gains are considered long-term capital gains, which are generally taxed at lower rates than ordinary income.

It can be tempting to hold onto your shares with the goal of getting the favorable long-term capital gains treatment, but that’s often not the best move. Having a lot of money invested in any single company’s stock is generally risky, and it’s even more so when it’s your employer’s stock and you already have a lot of financial risk tied to the company.

Plus, there are some pretty cool ways to use that ESPP money if you’re willing to sell right away, such as…

How to Make Your ESPP Self-Funding

This is our favorite thing about ESPPs.

If you do it right, you can make your ESPP a self-perpetuating, return-generating machine that funds itself once you get it going with your initial contributions. Here’s how it works.

Let’s say that you’re paid twice per month, you contribute $500 per paycheck to your ESPP, and that each offering period is six months long. During that first offering period, you have to be able to afford the contributions yourself. $500 will be taken out of each paycheck and set aside to purchase your ESPP shares.

However, once that six-month offering period is up and your first round of shares is purchased, you can do the following:

1. Immediately sell your shares. This will give you at least $6,000 in proceeds, but with a 15% discount it would be $7,058, and it could be more if the share price has increased.
2. Transfer the proceeds to a savings account.
3. Set up an automatic transfer of $500 from that savings account to your checking account, timed to coincide with your paycheck. This will offset the $500 being taken out of your paycheck, meaning you’ll have the same amount of money in your checking account as you would without a contribution, even though the contribution is still happening.
4. Repeat at the end of every six month offering period.
5. Since your ESPP proceeds are likely greater than your contributions, you can use the extra to either fund an increase in contributions or you can funnel it towards other savings and investment goals.

This is an incredibly powerful strategy that, when executed correctly, can provide almost guaranteed returns without any cost to you beyond the initial contributions.

Putting it into Practice

1. Are Your Financial Basics Covered?

Before putting money into an ESPP, make sure you’ve:

• Built an emergency fund covering 3-6 months of expenses.
• Paid off high-interest debt (like credit card balances).

The potential gains from an ESPP are exciting, but they shouldn’t come at the expense of your financial security.

2. Are You Maximizing Retirement Accounts?

If your company offers a 401(k) match, take full advantage of that before contributing to an ESPP—it’s free money! Plus, 401(k)s and IRAs offer tax benefits that an ESPP doesn’t.

It’s also worth asking: Are you maxing out other tax-advantaged accounts, like a Roth or Traditional IRA? Diversifying through retirement accounts can reduce your risk and boost your long-term returns.

3. Are There Trading Restrictions on Your Company Stock?

Some companies limit when you can sell your ESPP shares, often restricting sales to specific trading windows. This creates a bit of risk—if the stock price drops before you’re allowed to sell, you could lose part of your gains.

Make sure you understand any restrictions on selling your shares. The longer you hold the stock, the more exposure you have to potential price fluctuations.

Using Your ESPP to Supercharge Your Plan

When used correctly, an ESPP can be a powerful tool for generating predictable returns and building long-term wealth. If you’ve already covered your other financial essentials—like emergency savings and debt management—and set it up to be self-funding, your ESPP can truly supercharge your financial plan.

Not sure if an ESPP is right for you or how to get the most out of it? Fruitful’s financial guides are here to help. We’ll provide personalized advice to make sure your ESPP aligns with your bigger financial goals—so you can reap the benefits without putting your progress at risk.