The company you work for may allow you to buy company stock at a discounted price, explains CNBC in its recent story, “What you need to know about your employee stock purchase plan.”
The article explains that the formal name for this is an "employee stock purchase plan," or “ESPP.” If it’s used right, these stock purchases can increase your bottom line.
Let’s look at how an ESPP works.
You’ll typically get an email or memo that says your employer is going to allow you to buy its stock at a discount, maybe something like 10 to 15%. If you choose to participate, the deductions are taken from your paycheck, just like your 401(k) contributions.
Employee contributions accumulate between the offering date and the purchase date. At the purchase date, the company uses the accumulated funds to purchase shares in the company on behalf of the participating employees. Therefore, the stock is purchased in bulk at one point in time, along with other employees' contributions. These purchases typically occur every six months.
An employee can then sell those shares right away and lock in the gains from the discounted price he or she paid, or they can hold on to the shares for later.
If you'd like to hold your employer stock for preferred tax treatment, it’s wise to wait until at least one year after the purchase period and two years after the initial offer date. The gains will be taxed as long-term capital gains, which are typically taxed at a lower rate than ordinary income.
Note that there’s usually a limit to how much you can invest in an ESPP, perhaps up to $25,000 per year or 15% of your salary.
If you can afford the payroll deductions, the ESPP is a nice way to invest in your company stock at a discounted rate. However, you should balance this investment with your other financial priorities.
Reference: CNBC (August 15, 2018) “What you need to know about your employee stock purchase plan”