Employee Stock Purchase Plans (ESPP), Employer Profit Sharing Plans, and Employer 401K contributions are the easiest ways to generate passive income, provided one is employed. Amongst these, profit sharing plan is automatic since virtually no action is required on the employee’s part to avail this benefit. ESPP and Employer 401K contributions on the other hand require opting in. The process of opting in can vary by plan.
Profit sharing plans puts in a percentage of the salary to an employee account – the percentage is derived from a formula that is tied to the company’s profit. Most common downside with profit sharing plans is that the contribution makes its way to the employee’s retirement account, usually the 401K account. Generally this is in the guise of shares in the company’s common stock. A vesting period for these shares is more of the norm. A critical aspect of this is that employees tend to overlook the need to diversify out of company stock.
In a typical ESPP plan, opting in requires signing up and assigning a percentage of salary (limited to $25K/annum fed mandated maximum) as the amount to be used to purchase the stock. During the offer period (usually 6 months) the money will be accumulated in a company account and it can be equated to receiving a portion of your salary at the end of the 6-month offer period as opposed to every 2 weeks. The benefit is that the stock is purchased at a discount (typically designed so as to be over 5%) at the end of the offer period. By selling the stock at the end of the offer period, passive income is realized. The downside with ESPP is that one has to forgo part of the salary during the offer period.
For Employer contributions to a 401K plan, opting in requires signing up and assigning a percentage of salary (limited to $15.5K/annum fed mandated maximum plus $5K/annum catch-up contributions for those over 50) as the amount the employee contributes to the account. Employer contributions to such plans are designed such that the percentage contributed is dependent on the employee contribution. A common plan is employer contributing 50% of up to 5% of the employee contribution. In this scenario, passive income of 2.5% of the salary is realized by opting to contribute 5% to the 401K plan.
The downside with all of these passive income strategies is that once the rat race is successfully exited, the income steam also ceases. Hence, the strategy should be to use these income streams as building blocks for other forms of passive income while still in the rat race.
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Profit sharing plans puts in a percentage of the salary to an employee account – the percentage is derived from a formula that is tied to the company’s profit. Most common downside with profit sharing plans is that the contribution makes its way to the employee’s retirement account, usually the 401K account. Generally this is in the guise of shares in the company’s common stock. A vesting period for these shares is more of the norm. A critical aspect of this is that employees tend to overlook the need to diversify out of company stock.
In a typical ESPP plan, opting in requires signing up and assigning a percentage of salary (limited to $25K/annum fed mandated maximum) as the amount to be used to purchase the stock. During the offer period (usually 6 months) the money will be accumulated in a company account and it can be equated to receiving a portion of your salary at the end of the 6-month offer period as opposed to every 2 weeks. The benefit is that the stock is purchased at a discount (typically designed so as to be over 5%) at the end of the offer period. By selling the stock at the end of the offer period, passive income is realized. The downside with ESPP is that one has to forgo part of the salary during the offer period.
For Employer contributions to a 401K plan, opting in requires signing up and assigning a percentage of salary (limited to $15.5K/annum fed mandated maximum plus $5K/annum catch-up contributions for those over 50) as the amount the employee contributes to the account. Employer contributions to such plans are designed such that the percentage contributed is dependent on the employee contribution. A common plan is employer contributing 50% of up to 5% of the employee contribution. In this scenario, passive income of 2.5% of the salary is realized by opting to contribute 5% to the 401K plan.
The downside with all of these passive income strategies is that once the rat race is successfully exited, the income steam also ceases. Hence, the strategy should be to use these income streams as building blocks for other forms of passive income while still in the rat race.
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