Haven’t you ever wanted to get money for free? Damn straight you have! This article will let you in on a couple of potential ways to do just that.
The 401K and IRA will involve some level of sacrifice, meaning that you are essentially not going to touch until age 59 1/2 at least. This is a small sacrifice you should already be willing to make if you’re contemplating financial independence and are smart with your money.
The only sacrifice involved with the ESPP plan I outline is that you will need to be able to make things work with 15% less money in your paycheck for an initial 6 month period. If you are serious about reaching financial independence, and take an honest look at your necessary spending, you should be able to make that work.
As an added bonus, once you’ve done this for 6 months, it will become habit and you can continue to do it and invest that money plus the guaranteed profit (explained below). Pull this off and you will have increased your savings level by 17.25%, which is an awesome achievement! It’s painful, but it can be done. I’m living proof, though my Comcast subscription, pet insurance, Starbuck’s habit, and some other mostly useless expenses that I had accumulated over the years were not so lucky.
1# – 401K – Please, please, please, tell me you already know about this one. If you’re not at the very least contributing the amount needed to get 100% of your company match, you need to start doing that immediately! My company gave me over $7,000 dollars last year alone. That’s $7,000 for essentially doing nothing at all except investing in my own future. If possible, I recommend that you max out your contribution amount every year to hide even more of your now dollars from taxation, but I realize that is not always achievable.
If you are young and in your first few years of working, trust me on this, I guarantee that you will not look back later in life and wish that you had not contributed as much to your 401K. Yes, you are young, yes a 401K locks your money away for years and years, but it’s like a pot of gold that will grow itself into a mountain of gold. Like I said earlier, at the very least, you need to make sure you get every single dollar of your company match. It’s free money!
#2 – IRA – Assuming your gross adjusted income is below $194,000 you can essentially get paid now by saving money for later. I wish I had discovered this one sooner, because I now can’t qualify due to the income limits (1st world problem, i know).
So how does this work? Here’s an example. Say you are in the 25% tax bracket and have $50,000 of taxable income after all of your deductions. You would owe $12,500 in federal tax for the year. So now let’s say that you contribute the maximum of $5,500 into an IRA. This would lower your taxable income dollar for dollar, bringing it down to $44,500. This in turn reduces your tax obligation from $12,500 down to $11,125.
That means you get a 25% investment return on the $5500, for a total of $1,375. This will materialize in the form of a smaller check you have to write to the IRS or bigger tax refund when filing your taxes.
A 25% guaranteed return is ridiculously good, sign up for those every single chance you get. Keep in mind that the percentage will depend on your tax bracket, and filing status. Another interesting fact is that you can wait until tax time the following year to make your contribution, but make sure to double check as each year the specific dates change each year. So, 25% returns are amazing, but this next one’s even better.
#3 ESPP – An Employee Stock Purchase Program is exclusively for employees of publicly held corporations. If that’s you, it’s literally a guaranteed free handout from the company if you play your cards right.
Here’s how it works at my company. I’m allowed to defer anywhere between 1% – 15% of my after tax dollars (with a yearly cap of $25,000). I choose to max out at 15%, because the higher the %, the more free money I get. This deferred money is put into a holding account (0% interest, 0% risk*) until the end of the current holding period which are semi yearly, so 6 months. So every time I get paid during that 6 month period, 15% of total after tax dollars are put into the holding account.
At the end of the 6 month holding period all of those dollars are used to buy shares of my company stock. Here’s where the free money kicks in, so pay attention. I get to buy the shares at a 15% discount! No brainer right?
What if the stock went down during that 6 months you ask? Never fear, here’s where it gets really cool! The 15% discount is applied to the stock’s price on either the first or the last day of the holding period, whichever one was cheaper. So let’s say that on day 1 the stock price was $100 and on day 180 it was $50. I would pay $42.50 for each share (15% of $50 = $7.50, so $50 – $7.50 = $42.50). While this would mean my company is sinking badly, I would still make a 15% profit on this deal if I sell my shares immediately at $50 each.
If the tides were turned and on day 1 the stock price was $50 and on day 180 if was $100, I would still get to buy the stock for $42.50 and be in line for a massive profit on top of that 15% when I sell the shares at $100 each.
Now here’s where I get really conservative. I sell my shares on the very first day that I can as soon as the market opens. I pay a higher tax rate than if I held the shares for 12 months (regular income vs long term capital gains), but I do it anyway.
The only catch here is that there is a short lag between when the purchase price is set and when you can sell your shares. At my company it’s usually one week, but please do check this out at your company, as you are exposed to a loss during this period if the day 180 price is lower than the day 1 price and the price drops by more than 15% during that week’s time. Highly unlikely, but better to be educated ahead of time.
My thinking on selling immediately is that I already have a ton of risk and exposure tied up with the company that I work for in the form of unvested RSUs, not to mention my entire income stream, so I don’t get greedy. I take the free $$ while it’s guaranteed and put it into other investment vehicles. By selling on the first eligible day, I’m essentially guaranteed a minimum of 15% profit on the entire amount that I deferred. Good luck finding another investment option that pays a guaranteed minimum annual profit of 30%**.
Fortunately, my company’s stock has been maintaining a steady upward trajectory and I’ve made significantly more than 15% over the life of the program. If you’re a risk taker in a high tax bracket, it might be worth it to hold for 18 months and pay the significantly lower tax that capital gains offers, but 18 months is a long time and the stock price could easily go down more than 15%, which would wipe out all of that free $$.
Let me know what you think!
Thanks for your time!
* Nothing is absolutely risk free, and in theory there might potentially be situations where you could lose money. Say your company or the bank with the holding account goes bankrupt, could end badlyAlways do your own due diligence when investing your hard earned dollars.
** 30% annual profit is a conservative # if you factor in that it’s a rolling contribution and I make 15% even if the last dollars that I put it were only in there for a few days. I’m sure there’s a formula out there to do a legitimate calculation, but someone much better than I am at math would need to figure that one out.