Author Topic: ESPP vs After-tax 401k (MegaRoth)  (Read 4001 times)

Ramza Beoulve

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ESPP vs After-tax 401k (MegaRoth)
« on: November 17, 2015, 07:47:02 PM »
I work for a Fortune 50 healthcare company so I don't envision the stock crashing out on me.

ESPP
  • 10% Discount on the Stock based on the closing price that day
  • Can be purchased, on a after-tax basis, once a month, through salary deduction or a cash purchase
  • Maximum of $25,000 a year
  • Required to be held at Fidelity for 90 days after purchase
   

After-Tax 401k
  • Placed in a stable value fund
  • Up to four in-service withdrawals per calendar year or in-plan Roth conversion
  • Eligible to hit the 53k limit
  • 401k has really good ERs, the highest ER on a passive fund is 0.08

I am in the 28% tax bracket with no state income tax, so if the stock does not budge in 90 days, I make a 7.2% return on $6250 every 90 days. So is the ESPP the better choice, the priority? It is  impossible even with company match plus my contributions to hit the 53k annual limit.

Goldielocks

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #1 on: November 17, 2015, 08:04:44 PM »
A single stock is not a Vanguard whole market ETF.  There is quite a bit of risk there, for a 10% (before tax) reward.

I invest in the ESPP, but I have a 50% match to make it worth my while, and only after I have maxed out all other retirement accounts.

So -- I would still go for the 401k.

Hey It's Me

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #2 on: November 17, 2015, 09:49:43 PM »
Those are some strict rules for the ESPP. For reference, mine is purchased at a 15% discount and you can sell immediately. Stocks are purchased every six months.

That said, because your company allows stock purchases on a monthly basis, that significantly reduces the risk of owning a single stock for 3 months. In the way the program is set up currently, even if your company's stock price drops by 50% in a month (and stays steady after that), you would still only be down 7% overall by the time you can sell the first month's stocks. (Let me know if you want me to run you through the math on this.)

ALSO, after the sale, can't you shift this money through the Mega Roth, anyways? Basically you'd be doing the same thing + the benefit of the upside of ESPP. This is what I did with my ESPP (though with my IRA and HSA).


msilenus

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #3 on: November 17, 2015, 11:17:02 PM »
Do both! 

1) That's a decent ESPP.  15% discount is really good.  With a 1 month holding period, your annualized return on the sequestered money is something crazy.  So take it, and sell stock every 30 days, immediately once the stock has "aged" 90.  Move it to checking afterwards and live off of it, if you have to.  If you have any kind of emergency fund, you're plenty liquid enough to bootstrap this and give yourself a ~$3.5k-$4.5k raise. 

Your emergency fund needs decrease somewhat because you could always suspend ESPP participation to dramatically increase cashflow.  (Once you suspend you'd still be getting stock sales from your 90 days "pipeline", but you'd also stop deferring so your paycheck goes up.)  Probably still want to put some of that "raise" into replenishing the e-fund, though.

2) Now that you're living partially off of stock sales, doesn't that create room in your paycheck to increase AT 401(k) witholdings?  Yes it does.  You created even more room to do that than you deferred into the ESPP.  (Because the discount is turning into cash in your pocket.)

If you insist on choosing one or the other, definitely take the free money.  (ESPP.)
« Last Edit: November 17, 2015, 11:21:18 PM by msilenus »

seattlecyclone

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #4 on: November 18, 2015, 01:21:25 AM »
ALSO, after the sale, can't you shift this money through the Mega Roth, anyways? Basically you'd be doing the same thing + the benefit of the upside of ESPP. This is what I did with my ESPP (though with my IRA and HSA).

Yes, this is key. The ESPP is not like the 401(k) where you keep putting new money in and leaving it there indefinitely. You're selling new shares after 90 days so you should only have 3-4 months' worth of contributions in there at one time. Once you have this maxed out, you can use the ESPP as a pipeline, putting money in there with your paycheck and taking it out three months later to pay living expenses. Then ratchet up the 401(k) contributions once you've built up your ESPP pipeline.

Ramza Beoulve

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #5 on: November 18, 2015, 06:41:58 AM »
That said, because your company allows stock purchases on a monthly basis, that significantly reduces the risk of owning a single stock for 3 months. In the way the program is set up currently, even if your company's stock price drops by 50% in a month (and stays steady after that), you would still only be down 7% overall by the time you can sell the first month's stocks. (Let me know if you want me to run you through the math on this.)

From what I've read, I believe the strategy is to fund $6250 at the start of the year, sell after 90 days and repeat. Is the better strategy to split it up and buy a month at a time, rather than every 3 months, to better guard against market volatility?

msilenus

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #6 on: November 18, 2015, 10:46:34 AM »
From what I've read, I believe the strategy is to fund $6250 at the start of the year, sell after 90 days and repeat. Is the better strategy to split it up and buy a month at a time, rather than every 3 months, to better guard against market volatility?

It's going to depend a little on transaction costs, but conventional wisdom is that you want to minimize exposure to your employer.

If you're using proceeds to fund living expenses (to free up paycheck dollars for AT 401(k) contributions), then that makes it even more important to minimize exposure to the market.

neil

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #7 on: November 18, 2015, 11:05:48 AM »
I don't know why this is an either-or situation.  Once you are enrolled in ESPP, your cash flow is back to normal after the holding/vesting period.  The only real question is if you are bothered with holding a rolling 90-day period worth of stocks.

If I understand the rules, it seems like you can do any amount at any time in the year, with a maximum total of $25K.  It might be more work to manage, but breaking this up monthly will minimize your short term risk.  You can run the data in Excel if you are interested in a history of the results.  In general, 90 days is not a very safe period to hold stocks and sometimes you will definitely be holding losses (but gains should occur as well, unless your company is on a death march to zero).  You will also have to be disciplined not to market time on your selling prices.  No matter how much you understand this point, it is still hard sometimes.  The last time my company's ESPP executed, the market went on a significant dive the very next day.

Goldielocks

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #8 on: November 18, 2015, 03:14:48 PM »
ALSO, after the sale, can't you shift this money through the Mega Roth, anyways? Basically you'd be doing the same thing + the benefit of the upside of ESPP. This is what I did with my ESPP (though with my IRA and HSA).

Yes, this is key. The ESPP is not like the 401(k) where you keep putting new money in and leaving it there indefinitely. You're selling new shares after 90 days so you should only have 3-4 months' worth of contributions in there at one time. Once you have this maxed out, you can use the ESPP as a pipeline, putting money in there with your paycheck and taking it out three months later to pay living expenses. Then ratchet up the 401(k) contributions once you've built up your ESPP pipeline.

Ah,  missed that part.  My ESPP is very generous, but if I touch it before 2 years, the matching ends for 2 years...   The result is that $40k built up there very fast, and that was way too much in a single stock for me.

If you can keep your total invested low, say under $5k, while almost guaranteeing 5-15% returns, sound like a plan.

frugalnacho

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #9 on: November 19, 2015, 09:37:34 AM »
So is the ESPP the better choice, the priority? It is  impossible even with company match plus my contributions to hit the 53k annual limit.


bgp

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #10 on: November 24, 2015, 04:45:44 PM »
Ramza - I would go for the MegaBackdoor Roth first. I have concerns about your ESPP but like the return. For me the 90 day holding period would be the issue. That risk has a potential to wipe out your return. The good news is your return is significant.

Assuming you put in the full amount via the cash purchase option; The $22,500.00 in cash purchases company stock worth $25,000.00. Let's say you hold for 90 days and the price per share is the same as it was 90 days ago.

A 10% discount is an 11.1% return
APR would be equivalent to 44.4%
APY would be 52.4%

(these percentages are more obvious if you use the same $5625 each quarter to make your purchases)

The problem is that 90 day hold. Assuming my example, you have $25,000.00 in stock. A 10% drop wipes out your return.

Many ESPP have a zero day hold (or just a few hours from market close to market open) helping reduce the holding risk. The other issue is you will have your funds tied up longer in a much riskier asset then you may want.

Given the very nice return and notes about a stable company it sounds like a potential money maker.
« Last Edit: November 24, 2015, 06:39:12 PM by bgp »

frugalnacho

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Re: ESPP vs After-tax 401k (MegaRoth)
« Reply #11 on: November 25, 2015, 09:58:09 AM »
I think bgp is totally over blowing the risk to a 90 day holding period.  You will probably perform multiple transactions throughout the year as you earn money, not one lump sum of $25k.  The odds that each and every separate 90 day holding period loses 10%+ is pretty remote.   It's still a gamble, but the odds are heavily tilted in your favor.