People working in tech and other sophisticated industries are often smart, well-educated, hard-working, and passionately dedicated to their jobs. You might assume they have a good handle on their personal finances as well. But while some do, many do not.
When someone from tech, for example, comes into my financial planning office for an initial consultation, they’re often unclear on a variety of issues that matter in big ways — like if their start-up company stock options are incentive stock options or non-qualified stock options, how much they’re contributing to their 401(k) and how that money is invested, what the after-tax value of their public company restricted stock units (RSUs) are, whether they should contribute to the employee stock purchase plan (ESPP), how much house they can afford in the high-cost tech city where they live, and a dozen other important details that impact when they can retire and how they can meet other financial goals.
It’s not surprising when you think about it. Personal finance isn’t usually covered in K-12 education, and it’s equally absent from coursework in STEM majors like engineering, computer science, and the life sciences. Companies aren’t providing training on personal finance either. This means employees are relying on parents, friends, coworkers, and ad hoc Google searches to build their knowledge base. Oftentimes, it’s not pretty.
Many companies do a good job making available basic information on benefit plan features through a variety of resources, such as internal websites, meetings with the 401(k) provider’s representatives, and webinars during benefits open-enrollment periods. But the higher level understanding and strategy of when and how to use benefits — for example, when to save to a 401(k) versus an ESPP — is often missing. And without that, employees can’t maximize the full range of benefits they’re offered.
Though the trend is to provide some financial services, many companies still take the position that personal finance is not something they should get involved with; that it’s up to the employees to teach themselves what they need to know or hire outside tax and financial advisors to manage their finances for them.
Employers getting involved
But there is another perspective. As a modern employer competing in a tight job market, you’re already involved. You’re already providing some, most, or all of employee household income through salary and bonuses that cover living and recreation expenses. You’re already providing healthcare plans that pay for the majority of healthcare costs. You’re already providing defined contribution retirement plans (instead of traditional pensions). You’re probably already providing equity compensation in the form of restricted stock, stock options, RSUs, or an ESPP, which allows employees to share in company success and save for retirement or maybe even fund early retirement, particularly in start-ups.
You’re already very involved in personal finances. Add to this the fact that larger companies also often offer meals, day care, and on-site gyms. Why not financial education too?
Financial benefits are incredibly complicated programs. And let’s not kid ourselves, the plan documents and other required disclosures are not enough. Employees could use help in understanding and using these programs. And they want this information.
As employees grow their knowledge in these areas, benefits also accrue to employers. Employees with a solid financial situation are less likely to be distracted at work by money problems or to job hop looking for a slightly better compensation package.
If your company is open to working with employees to expand their understanding of benefit options and more general financial strategies, there are plenty of subjects financial planners often discuss with employees that would be good places to start. The ideas here are just a few examples. Educational conversations around these topics could be incorporated into the employer-employee relationship without giving individual financial advice, which could raise liability concerns.
Most employees should be contributing to their 401(k) retirement plan, particularly if the company offers a matching contribution. This is something most employees are aware of, but it is important for them to understand why. Regular 401(k) contributions allow employees to save for retirement while also reducing current taxable income. And the tax savings can be substantial for highly paid professionals.
Take, for example, an employee living in California who files a joint tax return with her spouse, has taxable income (all ordinary) of $250,000, and makes a maximum allowable pre-tax contribution for 2019 of $19,000 ($25,000 if over 50 years old). She is in the 24% federal tax bracket and 9.3% state tax bracket. Her $19,000 contribution only “costs” her $12,673 because her federal income tax is reduced by $4,560 and her state income tax is reduced by $1,767 as a result of the contribution. Basically, the government paid for a third of the contribution.
Not every employee can attain the maximum contribution due to other saving priorities. But if the company offers a matching contribution, employees should generally, at a minimum, contribute the amount required to earn the full matching contribution. Matching contributions are “free money” and one of the only ways employees can give themselves a raise.
Regular 401(k)s are generally preferred over Roth 401(k)s for employees in high tax brackets because the income tax reduction on current regular (pre-tax) 401(k) contributions is more valuable than tax-free withdrawals on Roth 401(k) contributions in retirement. That being said, the exact answer to the question of which type of 401(k) contribution someone should make depends on assumptions about future tax rates and investment rate of return and usually requires individual analysis.
Do what first?
401(k) money is essentially locked up until age 59½ in most cases, due to a 10% early withdrawal penalty and the fact that 401(k) withdrawals are taxed as ordinary income in the year of withdrawal. It can be expensive to take money out of 401(k) plans before reaching 59½. As employees build their 401(k) savings, they are creating a big pile of illiquid assets, which is necessary for the future but could be problematic if they don’t also have other types of accounts to access for more immediate needs. But what other types of accounts make sense? Looking at the bigger picture, what types of accounts are useful for saving and in what order should they be funded? This information is truly valuable to any employee population and should be easy to incorporate into employee benefit education.
Even before saving in a 401(k) plan, most financial planners recommend first establishing an emergency fund with three to six months’ worth of living expenses saved in cash. The emergency fund can cover periods of unemployment or illness along with major unexpected expenses.
Saving for any planned major purchase, such as a home, is usually next on the list of savings priorities after creating an emergency fund and before contributing to a 401(k). Short-term, high-quality bond mutual funds are a good place to keep major purchase savings for one to three years until needed, allowing savers to earn a little higher interest rate than with a bank account without risking the money in the volatile stock market. This money needs to be there when it’s time to make the purchase.
After the emergency fund and major purchase savings, it’s then a good time to focus on a 401(k) (or other retirement plans or accounts). Again, whenever possible, it’s best to contribute as much as needed to get the full matching contribution.
Next, and nearing the end of the list, is saving for retirement in a taxable (and more liquid) brokerage account. This is where most additional savings gets directed once tax-deferred vehicles have been maxed out. College savings might be in the mix here as well, with 529 educational savings accounts being a good avenue for most people. Family priorities guide the amounts saved toward each goal.
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A basic framework such as this for making savings decisions can be enormously helpful for employees, and doesn’t require a company to give out individual advice.
Employee Stock Purchase Plan (ESPP)
Publicly traded companies frequently offer an ESPP to employees as an opportunity to earn more, contribute to the company’s success, and align employees’ interests with the company’s and shareholders’ interests. With an ESPP, employees can buy their employer’s stock over time at a discount of up to 15% or more from the market value. Employees can then sell their shares to earn the built-in investment gain. If employees sell their shares immediately after receiving them, they can lock in a guaranteed, nearly risk-free return. This is another form of “free money,” which is why employees should consider directing as much of their cash flow as possible to ESPPs that have the maximum 15% purchase discount.
The rate of return for ESPPs with maximum discount is actually higher than the 15% purchase discount. To calculate the rate of return, you divide the sale price (100% of market value) by the discounted purchase price (85% of market value) to arrive at a 17.6% investment return. There aren’t many, if any, other investments that consistently earn over 17% with little to no risk. For this reason, financial planners typically strongly encourage their clients to make use of their employer’s ESPP.
The investment return can be even higher if the ESPP allows “lookback” pricing, in which employees can buy shares at the 85% discount from either the current market price or the stock price at the beginning of the ESPP offering period. With companies whose stock price is appreciating, the lookback feature coupled with the maximum 15% purchase discount can mean investment returns for employees greater than 17.6%. And as a benefit to the company, an ESPP and other forms of equity compensation work to keep employees aware of the company’s stock price and motivated to do what they can to drive the price higher.
Other forms of equity
Forms of equity compensation, which include ESPPs, stock options, restricted stock, and restricted stock units, are complicated — employees often find themselves struggling to understand them. In particular, stock options, restricted stock, and restricted stock units bring their own complexity due to the unique taxation involved in each. For example, non-qualified stock options (NSOs) and incentive stock options (ISOs) have completely different tax treatment. Many employees don’t know which type of options they have been granted, which also means they aren’t doing any tax planning. And while many employees are aware that ISOs have favorable tax treatment, most are not aware that much of that advantage can disappear under the Alternative Minimum Tax (AMT), which leads them to overestimate the after-tax value of their stock options. Stock option early-exercise features and using the tax-saving 83(b) election for stock options and restricted stock are other common areas of confusion for employees.
Taxes and housing
There are other essential topics beyond (yet related to) benefits and saving that could be packaged succinctly for today’s ultra-busy workforce. How about a primer on federal and state taxes? Most of the complicated features of equity compensation, retirement, and healthcare plans are driven by tax law. A basic understanding of taxation is a prerequisite to understanding the features of, and strategy for using, employee benefits. It’s important even for the simple task of setting withholdings on Form W-4 that so many employees struggle with. How many employees realize that getting a large refund with your tax return might actually be a bad thing and means you set your withholdings too high and gave the government an interest-free loan all year? Not many. This is another area where you can incorporate useful, sought-after education into benefits workshops without offering individual tax advice.
Another area that generates plenty of interest is the high cost of housing in most tech cities and how to work with it. Employees often want to buy homes and so holding seminars around this goal can be invaluable. Good topics include how much home is affordable, how much an employee can afford to purchase, how mortgage loan qualification works, and the hidden costs of home ownership, such as property tax, maintenance, and inevitable remodels.
Through offering information on these subjects, you help to create a workplace culture of financial competence. Schools aren’t teaching personal finance, so maybe it’s time for private sector companies to dip a self-interested toe in the water to ensure their highly valued workforce is financially secure, and, because of this, more engaged in their work for the company.
Starting with financial education
One way to begin is to first increase staff knowledge about how employee benefit programs fit into employees’ financial plans. It’s helpful to know not only features of the various benefits offered but when and how to use which benefits and their tax consequences — this is the layer of financial strategy above basic benefit features. To help leadership and staff understand this level of strategy, they can have thorough financial plans created for themselves by a reputable, experienced financial planner who holds the Certified Financial Planner™ credential and works as a fiduciary (acting only in a client’s best interest). In addition to offering insight into the key financial planning issues your employees face, having experience with such a plan will also inform decisions in designing and implementing benefit programs that meet employee needs.
If you’d like to start providing education and resources around various topics, you have the ability to do so in various ways. Formats might include one-day in-house seminars, six-week lunch-time classes, a guest speaker series, and reference books stocked in the corporate library and stored as PDFs on a server or internal website. Younger employees, who need the information most, might particularly enjoy the social aspects of lunch-time get-togethers. Take into account your own company culture and build offerings from there.
Creating a culture of financial competence can add a new and valuable dimension to the employee and employer experience. Employees will grow and make better choices that suit their own futures and goals. At the same time, they’ll be more present while at work and feel more loyal to the company.
While venturing into personal finance education might not feel like an obvious direction for many companies at first, it can be a win-win for everyone.