Let employer stock bail you out

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If you are in need of some quick cash, dipping into your company stock purchase plan can be a much better deal than borrowing from your 401(k).

The advantages of borrowing from an employee stock purchase plan, or ESPP, are clear:

•    Company stock is held in an account that isn’t associated with a 401(k), so it can be cashed in without the penalties and tax implications that can come with a 401(k) loan.
•    The money doesn’t have to be repaid if you leave the company.
•    You don’t have to charge yourself interest.

Fidelity Investments, which manages both 401(k)s and ESPPs for employers, pointed out in a recent report that employees who take out a loan from their 401(k)s often stop saving. That’s a double retirement-planning whammy. Not only does it limit how much you accumulate for retirement, it also means you don’t get any available employee match. That’s like refusing to take part of your pay.

How ESPPs work

Not every plan is the same, but Emily Cervino, a certified equity professional and vice president at Fidelity, explains that many of them share common elements. The company sets an offering period — frequently six months. During that period, plan participants purchase stock by payroll deduction — money on which they have already been taxed. At the end of the offering period, the company uses that money to buy stock for the employee, usually at a discount rate. Generally, the employee discount is somewhere between 5 percent and the IRS-approved maximum of 15 percent.

Sometimes there is a “look-back” period — usually a year. The employee can pay the lowest price in that designated time period. Many companies offer either a discount or a look-back period, but some offer both.

An employee can usually choose to sell the stock whenever they want — within a day or two of purchasing it if they choose. Any profits — including those generated by the company discount — are taxed at either the long-term or the short-term capital gains rate, depending on how long the employee has held the stock. There also likely will be a small sales charge.

Building an emergency fund

As Cervino points out, “Most of us only have so many dollars available to save,” so if you think buying stock in an ESPP will pinch you, here is a technique that some people have found successful for building an emergency nest egg based on profits from their ESPP.

Start by letting your employer take a 15 percent deduction out of your pay for an initial offering period. Buy stock, then sell it immediately before its value has time to fluctuate.

If you’re getting a 15 percent employee discount, you’ll have made an immediate 15 percent profit. If you earn $50,000 a year, the first six months you’ll clear nearly $560. Put that money in a safe place, then repeat the process. After that initial offering period, you’ll be using the same investment money over and over, so you shouldn’t feel so short.

Within a couple of years, you should have accumulated at least a $2,000 emergency fund — enough to keep you from feeling tempted to borrow from your sacred 401(k).

Here’s more about how ESPPs work.