Let us first answer some basic questions about the ESPP.

What is ESPP?

ESPP is also called Employee Stock Purchase Plan. This is offered by some public companies where in they allow employees to invest in the company’s stock at a discounted price. Stock is typically offered at a discount of 15% and the purchase price is typically set for 2 years, the actual discount value will depend on the specific plan offered by your company. Based on IRS rule, the discount is capped at 15%. ESPP lets employees participate in their company’s stock price appreciation in a relatively risk free way. Table below illustrates the returns for different scenarios. 

Are there any limits on how much you can contribute to the plan?

            Yes there are limits on how much you can contribute to the plan. IRS specifies the following. Annual $25,000 Limit -- The terms of an ESPP must provide that no employee may be permitted to accrue the right to purchase stock under all ESPPs sponsored by the employer corporation and its related corporations at a rate that exceeds $25,000 in the fair market value of the stock (determined on the date of grant). In a change from the proposed regulations, the final regulations do not impose this limit only in the year the options are first exercisable, but instead provide that the ESPP limit increases by $25,000 for each calendar year during which the option is outstanding. Please refer to your company’s plan for the specifics of the limit.

How much should I contribute to the Plan?

            ESPP offers one of the best returns on Investment and you should try to contribute the maximum amount allowed by your plan. Assuming a discount of 15% and the market price of the stock on the date of the grant is $100, the table lists the return on your investment for various stock prices also assume that you invest $1,000 per month and you sell the stock as soon as it vests. This also assumes that you contribute to the plan for 12 months and the purchase happens at the end of 12 months, usually most plans work on 6 month schedule, ie you contribute for 6 months and purchase the stock every 6 months. The yearly vesting is assumed to simplify the example, for detailed returns use the Return on ESPP calculator.

Note that for the last scenario, when the price drops to $20, the plan limit of 250 shares (based on annual limit of $25,000 based on the fair market value of stock on the day of the grant) limits the amount you can invest in the plan.