ESPP vrs 401k contributions question

[RDamien]

I'll try to keep this very to the point but please let me know if more information is needed to give an opinion:

ESPP:
-Can use up to 15% after tax salary.
-Buys are made each quarter and are bought at a 15% discount
-Immediately vested, can sell stocks at any time.

401k:
-T Rowe Price various. I have a 70/30 split stocks/bonds. 50% SP 500 index, 20% "Europacific" stocks, 30% Bonds
- First 6% is matched
- I contribute 16% currently which allows me to max out the 401k per year.
- I am 37 years old.

Question: I was thinking 15% into the ESPP, 6% (to match) in the 401k. Does that seem prudent? I can not afford to fund both to the maximum, although I'd like to. I can swing 15% in one and 6% in the other though and that was my thought. So 15% in the ESPP, sell the stock immediately and put the proceeds into a regular vanguard IRA. Is that foolish?

My sticking point is the 401k is pre-tax and the ESPP I'd have to pay gains on. But, the market is not going to give me 15%. So I'm confused.

Any advice would be appreciated.

 

[youbet]

Assuming you ESPP issues shares every six months like mine did, this is relatively simple......

15% to ESPP and 6% to 401k for the first six months. When the ESPP issues you the shares after six months (at a nice 15% discount) immediately sell. You now have the money (plus the 15%!!!) to go 15% ESPP and 21% 401k for the next six months. Then, rinse and repeat.

The key is selling the ESPP shares immediately. That way you are only out the money the first six months. Afterwards you have the money to do both, including taking advantage of that juicy 15% discount on your company shares.

I did this for years and and it felt very, very good. Sometimes the value of company stock was significantly higher at the end of the six month accumulation period than at the beginning and therefore the profit was significantly more than the 15%. Those fond memories bring tears to my eyes. One of the few fond memories of my w*rking life and I truly miss those sources of free money MegaCorp provided...... Definitely take advantage of the ESPP!

Your proposal for putting the ESPP proceeds into a Vanguard IRA is good also, but doesn't carry the tax deferal benefit of the 401k.

Edit: just noticed, your ESPP only accumulates for a quarter. Even better. You're only missing the money out of pocket for 3 months. Same as I described above, just do it four times a year.

 

[ziggy29]

Assuming you ESPP issues shares every six months like mine did, this is relatively simple......

15% to ESPP and 6% to 401k for the first six months. When the ESPP issues you the shares after six months (at a nice 15% discount) immediately sell. You now have the money (plus the 15%!!!) to go 15% ESPP and 21% 401k for the next six months. Then, rinse and repeat.

Well, there are taxes...

 

[RDamien]

Assuming you ESPP issues shares every six months like mine did, this is relatively simple......

15% to ESPP and 6% to 401k for the first six months. When the ESPP issues you the shares after six months (at a nice 15% discount) immediately sell. You now have the money (plus the 15%!!!) to go 15% ESPP and 21% 401k for the next six months. Then, rinse and repeat.

Thanks for the response youbet. So is there a way to roll the sale over to the 401k directly then? To avoid capital gains taxes on the sale?

 

[tulak]

ESPP is going to be taxed as income (unless you hold the shares, which you shouldn't - imo). There's no way to roll it over to the 401k. Anytime you sell, you will incur a taxable event, unless your dealing with a tax-sheltered account.

I also participate in my company's ESPP plan, but I look at it as a short-term savings account. I give them the money for 3 months and then get a lump-sum plus n% (minus taxes, of course).

If you look at this way, you may find that you can fund more into your 401k than you initially thought. But personally, I would take the 401k match, then fully fund a Roth IRA, and then if I have extra cash, increase the 401k contribution.

 

[ziggy29]

The problem with my employer's ESPP is that it's often five weeks between the date the shares are bought and the day our employee trading blackout window goes away. These days that means a pretty good chance of a 15% decline before you can sell the "discounted" shares...

 

[tulak]

The problem with my employer's ESPP is that it's often five weeks between the date the shares are bought and the day our employee trading blackout window goes away. These days that means a pretty good chance of a 15% decline before you can sell the "discounted" shares...

That would definitely make me rethink my contribution. Fortunately our plan deposits the shares within a few days and for the most part, fluctuations in price have been a wash.

 

[FinanceDude]

How stable is the company in this economy?

 

[youbet]

Thanks for the response youbet. So is there a way to roll the sale over to the 401k directly then? To avoid capital gains taxes on the sale?

No..... As mentioned by another poster, you can't roll the sale directly to the 401k plan. You pay the taxes. But your issue of not being able to afford fully funding your 401k and fully participating in the ESPP goes away after the first three months since that is the length of time the funds are actually out of pocket.

As long as the period of time from the end of the accumulation period to when the shares are available to sell is short, say a week or so, it's hard to go wrong with a 15% discounted ESPP. You'll always make close to 15% minimum (minus any possible drop in value of your company stock over that few day period) and if the stock increases in price during the three month accumulation period, you make much more. I worked for a company whose stock was volatile (desirable for ESPP plans!) and had a six month accumulation period, so my profits varied from about 13% to 40% in six months. Very, very sweet deal, even though the money is taxable as ordinary income.

When I met folks at work who did not participate, or who participated and held the shares, I really wondered what they were thinking...... We were limited to participating with only 10% of salary. I would have eagerly put in 100%.

Edit: The tax situation is that the 15% discount is taxed as ordinary income regardless of the stock price. The capital gain is taxed as a short term capital gain which is the same rate as ordinary income.

 

[RDamien]

Thanks again everyone.

How stable is the company in this economy?

It's a very large company, I actually did well with the ESPP and holding a few shares last year, but then... well you know. It didnt hurt me much since I only held maybe 50 shares at any one time.

This time around though I would sell immediately after the buy. So the risk is small.

 

[ziggy29]

That would definitely make me rethink my contribution. Fortunately our plan deposits the shares within a few days and for the most part, fluctuations in price have been a wash.

Yeah -- for us, the trading window for employees closes about a week before the end of the quarter and reopens a couple days after earnings are announced.

Sometimes that's as much as about five weeks, which is the main reason I don't eagerly participate in the ESPP. A lot can happen to both the company and the overall market in five weeks.

 

[slouch]

Keep in mind that when you flip the ESPP it becomes a disqualifying disposition (commonly labeled as "DISQDISP" on your W2), which has different tax implications.

Dispositions of ESPP Stock

 

[cho oyu]

Thanks again everyone.



It's a very large company, I actually did well with the ESPP and holding a few shares last year, but then... well you know. It didnt hurt me much since I only held maybe 50 shares at any one time.

This time around though I would sell immediately after the buy. So the risk is small.

The risk may be small, but it is definitely still there. This is true especially now that the market is extremely volatile.

Over time, you will almost certainly win out (quarterly buys with a weekly pay deduction result in >100% annualized gain). However, be careful about counting on money immediately after the blackout is lifted.

I've only had one ESPP purchase period that went negative (no official blackout, just a 2-3 day period of lag between company buy and ability to sell), but losses can and do happen.

 

[youbet]

The risk may be small, but it is definitely still there. This is true especially now that the market is extremely volatile........... I've only had one ESPP purchase period that went negative (no official blackout, just a 2-3 day period of lag between company buy and ability to sell), but losses can and do happen.

I'd say that if holding a stock you just bought at a 15% discount for a few days is something you'd consider risky, you definitely shouldn't be in equities at all.

Over time, the odds are in your favor to make substantial profits. Buying at a 15% discount is one factor. But the more important factor is that you get to buy at the price established at either the beginning or end of the accumulation period, whichever was lower. That's the sweet part!