ESPPs: A Sale to Pass On?
September 21, 2010I recently sat down with an employee to create a financial plan as part of a financial coaching benefit that his employer offered as part of their overall wellness program. As we began discussing how he has his paycheck allocated, he told me about his 6% 401k deferral, his $50 HSA contribution, and his $50 a pay towards the employee stock purchase plan. His last option caught my attention because it didn’t quite fall in line with his 2 primary financial goals – retirement and saving for his son’s college costs. When I asked him why he had signed up for the ESPP, he said, “I’m buying them on sale!” since his employer gives a 5% discount to the stock price and no trading fees.
However, when we compared the ESPP with his other savings options, it became apparent that the “sale” could end up costing him more in the long run in taxes. That same $50 a pay towards his state’s 529 College Savings Plan would yield him a current year’s state income tax deduction in Arizona and tax-free growth. Or, stashing that $50 a pay towards his Roth 401k option could provide tax-free dollars in retirement. The 5% discount on the front end of buying company stock sounds good, but he didn’t realize that when he eventually sells his stock holdings for a profit, he will end up paying capital gains taxes – which would be at a 15% rate this year and could even go higher in the future due to pending tax law changes. We came to the conclusion that if he had been already maxing his 401k and already contributing to a 529 Plan for his son, then adding the ESPP as an additional investment strategy would make sense, but until he’s met those goals, he will be backing away from the “sale” on company stock.