You’re probably used to contributing to your employee stock purchase plan (ESPP) and accumulating stock in your company. Or you may wonder if you should even contribute to your ESPP along with your 401k and other forms of equity compensation. An employee stock purchase plan can be a valuable tool and used in many ways to increase your financial flexibility.
Before we dig in, most of the ideas in this post will revolve around selling shares from a qualified ESPP. When you sell shares, you’ll have a tax liability. Selling shares immediately won’t result in the most favorable tax treatment, but you’ll still benefit from the discount. This is also a simple way to use an ESPP since you won’t be on the hook for additional taxes and stock fluctuations. For a breakdown of ESPP basics and taxes, read this previous post.
It’s worth noting that even though you’ll owe taxes due to the sale of stock, implement a strategy that fits your personal situation first, then optimize for taxes. Of course, taxes are important with equity compensation, but they shouldn’t drive every decision.
Now let’s get started. Here are 5 ways to use your ESPP to improve your financial life.
Contributing to an ESPP can boost your efforts towards building wealth through long-term investing. Not only do you get a return on your money with the share discount, but it’s also a way to automate savings into long-term investments.
From an investment allocation standpoint, you get to enjoy long-term growth through the company stock or diversify into other assets. Either way, it adds another way to build wealth outside of retirement accounts, such as your company 401k, IRA or Roth.
If you decide to hold company stock, be sure to monitor your position. Especially if you have other sources of equity compensation. Equity compensated employees commonly find themselves holding large positions in company stock. Consider rebalancing into other investments if you find yourself highly concentrated in your company.
An ESPP can be an avenue to fund a Roth IRA. You can take advantage of the share discount, then use the proceeds to contribute towards a Roth. This can help you grow the tax-free part of your wealth savings.
Here’s how it would work — You participate in an ESPP, purchase the shares at a discount, and then sell the shares at purchase. After the sale, you can use the money to make a lump-sum contribution to your Roth IRA. Thus, the ESPP helps automate savings while getting the benefit of the share discount.
If you are above the income limits to make direct Roth IRA contributions, you might consider the backdoor Roth strategy. This is an advanced planning strategy that allows for Roth contributions when you’re above the income limits. But, again, work with your financial planner and tax professional before implementing this.
Employees often don’t participate in an ESPP because it can strain cash flows. However, it can actually increase cash flow when planned properly. After shares are purchased, they can be sold and inserted into your cash flow to supplement expenses. Very similar to how you would plan for a bonus. Although selling the shares will cause a tax liability, you’ll likely come out ahead on an after-tax basis.
Your paycheck will be a bit smaller when contributing to an ESPP becuase you are making payroll deductions. However, think of it as delaying income for a return on your money due to the discount.
Another benefit to this is you’ll put more focus on your cash flow, which can help improve overall spending and saving habits.
Depending on your financial health, this is one of the best ways to use an ESPP. Short-term goals are those things you want to accomplish in the next 5-7 years. An ESPP offers the perfect way to save — it’s automatic, and you get an instant return!
The after-tax return from selling shares when you purchase them will likely outweigh any savings account. This is worth mentioning becuase goals within 5 years should remain in cash for stability. Cash ensures you can meet the goal without stock volatility disruption.
Share discounts can help accelerate short-term goals, whether a vacation, a new car, home improvements, or a home downpayment.
Reducing or paying off debt can be one of the best feelings in the world. Instead of making extra payments to your debt, consider contributing the equivalent to your ESPP. Once the shares are bought, you can sell them and make a lump sum payment towards debt. This will help compound debt payoff. Of course, the benefit to this strategy will be dependent on the interest rate of debt, but most of the time, it’s worth exploring.
Maybe you’re paying an extra $100/month towards student loans. Instead, you could put this $100/month into your ESPP, buy company shares at a discount, sell them immediately, and then put a larger amount towards the loan.
As you can see, an ESPP can be utilized in many ways to improve your wealth and reach your goals. A good ESPP is typically a no-brainer as long as you can afford it within your cash flow.
When taking advantage of your employee stock purchase plan, it helps to know the plan specifics. The details of your ESPP will help guide your financial plan towards maximizing your money. If you have questions about your ESPP, how to implement a plan, or the tax implications, you can get in touch with us here.