The NASPP Blog

I often encounter confusion over the difference between 401(k) plans and ESPPs, as well as the misperception that these two plans don’t mix: employees should participate in one but not both. The truth is that participating in both plans can be great for employees. Moreover, recent research from Fidelity shows that offering an ESPP can enhance your 401(k)

Two Great Plans that Go Great Together

A 401(k) is a great tool to save for retirement: employees invest their own money on a tax-exempt basis (except for FICA), the company may offer a match as an incentive to participate, and, in many cases, employees are able to hold their plan assets in a variety of diversified investments.

With an ESPP, employees also invest their own money in the plan, but on a post-tax basis.  Instead of a match, most plans offer a discount. The ESPP is not a diversified investment (employees must sell their stock and pay tax on it to diversify) and, although employees can certainly hold their stock as along as they want, they are not incented to hold until they retire, as is the case with a 401(k).

Another difference between these two plans: the maximum contribution to a 401(k) is increased periodically for inflation, whereas, as far as I can tell, the $25,000 limit under Section 423 has not been increased since the section of the tax code was enacted.

A 401(k) is a great tool to save for retirement; an ESPP is a great way to provide employees with additional earnings that are more liquid than their 401(k) holdings and can be used for to meet employees’ other financial needs. In addition, an ESPP allows employees to participate in the company’s success; in a 401(k), employees’ assets are often invested in mutual funds or other alternatives that aren’t related to the company.

ESPPs and 401(k) Loans

Recently, Fidelity compared loan rates against 401(k) plans for companies that offer an ESPP and those that don’t.  As highlighted in a recent article in Plansponsor (“ESPPs Can Help Insulate Retirement Savings,” June 12, 2015) and Fidelity’s own announcement (“How Can Companies Help Employees Avoid 401(K) Loans? Offer an Employee Stock Plan, According to Fidelity Survey“), the results were enlightening:

• 401(k) loan rates were lower across the board when companies offer an ESPP, regardless of company size.
• Employees with access to both an ESPP and a 401(k) tend to borrow a smaller amount from their 401(k), and had a lower outstanding loan amount.
• Employees at large companies (more than 10,000 employees) with both an ESPP and 401(k) borrowed an average of $2,000 less than employees with only a 401(k), and had an average outstanding loan balance of $3,000 less than employees without access to an ESPP.
• The difference was especially notable among small companies (fewer than 500 employees), where 9% of workers took out new 401(k) loans when an ESPP was also available, versus 14% at companies that don’t offer an ESPP.
• The outstanding loan rate at small companies was also significantly lower, with only 14% of ESPP/401(k) workers having an outstanding 401(k) loan balance, compared with 23% of employees at 401(k)-only companies.

Want to hear more about how great ESPPs are? Attend the session “The New Role of Employee Stock Purchase Plans” at the 23rd Annual NASPP Conference.

– Barbara