ESPPs 101: Key Dates And Terms You Must Know
Podcast included: In addition to reading this article, you can listen to our podcast on the basics of ESPPs. For other podcasts, see the podcast section of this website. See also our our video on key ESPP rules and decisions.
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Your employee stock purchase plan (ESPP) may be one of the best benefits your company offers. A study of behavior among ESPP participants found that ESPPs can meaningfully improve employees' financial well-being. However, to maximize your ESPP's value, you must know its key dates and terms. This article explains the basics you need to know for your ESPP participation. The next article in this series discusses ESPP taxation.
An ESPP is a type of stock plan that allows you to use after-tax payroll deductions to acquire shares of your company's stock (this differs from a 401(k) plan, to which money is contributed before tax withholding). Plans can have different contribution rules and features and some of the terms do not have universal definitions.
The most common type of ESPP is known as a Section 423 ESPP. This type of plan is "tax-qualified" because it meets certain requirements set by Section 423 of the Internal Revenue Code, and therefore offers tax advantages. ESPPs that do not meet the requirements of Section 423 are called nonqualified ESPPs. Both types of plan tend to use the same terminology.
To get a full understanding of your company's employee stock purchase plan, including its key dates, you should carefully review:
- brochures, FAQs, and any other print or online material about the plan and how it works
- enrollment forms for the plan, along with the terms, conditions, and company procedures
How To Participate In Your Company's ESPP
Procedures, rules, discounts, and contribution limits can vary among companies. Generally, however, to enroll you complete a subscription form or agreement that authorizes payroll deductions and submit it to the appropriate office or department before the applicable enrollment date (e.g. by the 15th of the month before the beginning of a quarter). Your company may call this the "election" period. Some companies let you enroll online through an internal website or through a designated stock plan provider (i.e. a broker or a transfer agent).
Alert: Once you decide to participate in the ESPP and authorize payroll deductions, you may need to revoke this election in the future to avoid being automatically enrolled in new offering periods. Also confirm whether your company automatically enrolls new eligible employees in the ESPP (with the right to withdraw before the purchase date), though this practice is much less common with ESPPs than it is in 401(k) enrollment.
Enrolling After The Start
If you want to enroll after the initial enrollment period begins, check with your company for when (or whether) it will permit this. Plans with longer offering periods (e.g. 12 or 24 months) and purchase dates at regular intervals (e.g. every six months) can allow for periodic grant or enrollment dates. This allows new hires and existing employees to enroll during the offering period or even the purchase period. For example, you might be allowed to enroll every six months on specific dates.
Key Dates In Your ESPP
The discussion below explains the major ESPP dates and events you should know. While the terms we provide here are the ones most commonly used, terms can vary among companies.
It may be helpful to start with a sample timeline of a typical ESPP life-cycle. (Click on the image below to open in a new window.)
The structure of plans can vary, however. To understand your company's ESPP, it is important to learn the concepts and potential permutations of the various dates and periods.
Enrollment (Or Offering) Date
The enrollment date can be either the first day of the enrollment period or the enrollment deadline, depending on how your company (or outside stock plan provider) uses the term. The enrollment date can also be called the grant date. The maximum number of shares you purchase needs to be fixed by this deadline to avoid problems under ESPP tax regulations. (If your company has multiple locations in different time zones, confirm the time of day and the time zone used for the enrollment deadline.) The offering date is the first day of the offering period and usually follows soon after the enrollment deadline.
Alert: While you will need to decide on what percentage of your salary to contribute, up to a limit the company sets, your plan may allow you to reduce or increase your payroll deductions. Check on whether this is allowed and the deadlines for changes within a purchase period.
The grant date is usually the first day of the offering period. This is sometimes called the enrollment date. For numerous reasons, the grant date is important in ESPPs that are tax-qualified under Section 423. It starts the clock for tax purposes, determines the stock price to be used for calculating the annual limit of $25,000 on purchases, and serves as the point for calculating any lookback price.
Enrollment (Or Offering) Period
Usually the enrollment period is when you sign up to participate in your ESPP. However, at some companies it's the same as the offering period. During an offering period, payroll deductions are accumulated. Shares are typically purchased under the plan at the end of the offering period (the exercise or purchase date). Offering periods are not typically associated with open-market purchase plans.
Most Section 423 ESPPs have offering periods of either six months or some multiple thereof (e.g. 12 months or 24 months). Plans with offering periods of more than six months typically include interim "purchase periods."
Example: The offering period is 12 months. Shares are purchased at the end of each of two six-month periods within the 12-month offering period.
In this situation, with a lookback feature in the plan, the purchase price in any of these periods is based on the fair market value on either the first day of the offering period or the last day of the particular purchase period, whichever is lower. Companies can have longer offering periods (e.g. up to 27 months), with new offering periods starting every six months for employees to enroll in. At companies with rolling and simultaneous offerings, when the stock price is lower on a subsequent offering date than it was when you started, your plan may automatically enroll you in a fresh offering period with this new, lower lookback price.
The maximum offering period is 27 months for plans with a lookback feature but is five years for plans that use only the purchase date stock price (i.e. the up-to-15% discount is applied only to the end-of-period price). Plans often provide for multiple purchase periods (e.g. six months) within a long offering period.
Some companies interchangeably use the terms "offering period" and "purchase period" when these are the same length (e.g. six months). Other companies have longer offering periods containing shorter purchase periods. In these situations, a purchase period is an interim period within an offering period, generally when the offering period is longer than six months (e.g. 12 months or 24 months).
Example: The offering period is 12 months. Shares are purchased at the end of each of two six-month purchase periods (the "purchase date") within the 12-month offering period. The two purchase periods within the offering are: (1) January 2 through July 2; (2) July 2 through January 2.
Payroll contributions that accumulate during the offering period will be used to purchase whole (and sometimes fractional) shares of company common stock in your name at the discount price on the purchase date (sometimes technically called the exercise date). This purchase date is usually the last business day of the offering or purchase period.
Alert: Check whether your plan allows the purchase of fractional shares or only whole shares with your payroll deductions. If only whole shares, any amount remaining in your account may be rolled over to the next purchase period (without interest).
Withdrawing From The Plan (And Later Resuming)
Under most ESPPs, participants can withdraw from the plan at any time before the purchase (or exercise) date by giving written notice to the company. If you withdraw, either voluntarily or because of termination, you will receive all amounts previously withheld from wages that have not yet been used to purchase shares. Typically, no interest will be paid on this amount.
Alert: Procedures and deadlines for making a withdrawal vary from company to company. Ask your human-resources department, benefits unit, and/or any outside ESPP administration firm about the process and required notice period at your company.
Also check whether a waiting period is required after your withdrawal before you can re-enroll in the ESPP, or whether you can instead reduce your contribution, perhaps to $0. While companies understand that unforeseen financial circumstances can force you to pull out your unused contributions, they also do not want employees to use the ESPP as a savings account with the intention of withdrawing contributions just before the purchase date.
Generally, if you withdraw from the plan during a purchase period, you may participate in the next offering period. For plans with multiple purchase periods within a longer offering period, when you opt out of a purchase you must stay out for the remainder of the full offering period. When an ESPP has overlapping offering periods that start after each purchase, soon after withdrawing you can enroll in a new offering period. Review your plan to see how many offering periods it provides.
Alert: Review the form used to implement your withdrawal for the rules about resuming participation. The laws and regulations for re-enrollment in 401(k) plans do not apply to ESPPs, so your company can adopt procedures and deadlines to fit its administrative purposes.
When In Doubt, Ask The Company
Remember that ESPPs vary among companies. Therefore, it is always best to bring questions about specific plan details to the appropriate person, department, or outside firm that handles your company's ESPP administration (which may be separate from the administration of your company's stock option or restricted stock plans).
Once you have mastered the key terms and dates of employee stock purchase plans, you must understand ESPP taxation, which is the subject of the next article in this series.