What Your Employees Don’t Know About Their Finances Is Costing Them – And You

This article previously appeared on TLNT.com, a news and information website for human resource professionals. 

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, it’s possible many do not. 

When someone from tech, for example, comes into a financial planning firm for an initial consultation, they’re may be unclear on a variety of issues that matter — like if their start-up company stock options are incentive stock options or non-qualified stock options and how much they’re contributing to their 401(k) and how that money is invested. Employees may also want to know what the after-tax value of their public company restricted stock units (RSUs) are and whether they should contribute to the employee stock purchase plan (ESPP). They may also wonder how much house they can afford in the high-cost tech city where they live, and a dozen other important details that potentially 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 usually don’t provide training in personal finance either. This means employees rely on parents, friends, coworkers, and ad hoc Google searches to build this information. Oftentimes, it’s not pretty. 

Many companies provide basic information about 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 may not 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 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 I believe there is another perspective. As a modern employer competing for talent, 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 health care plans that pay for most health care 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 help employees share in company success, save for retirement, or fund early retirement, particularly in start-ups. 

You’re already involved in personal finances. Larger companies also often offer meals, day care, and on-site gyms to employees. Why not financial education too? 

Financial benefits can be incredibly complicated programs. And the plan documents and other required disclosures are not enough. Employees often need help understanding and using these programs. And they want this information. 

As employees learn more in these areas, employers may also benefit. Employees with a solid financial situation may be 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 help expand their understanding of benefit options and general financial strategies, there are plenty of subjects financial advisors often discuss with employees that would be good places to start. The ideas here are just a few examples. Employers can incorporate educational conversations around these topics into the employer-employee relationship without giving individual financial advice, which could raise liability concerns. 

401(k) strategy 

Many employees can benefit from contributing to their 401(k) retirement plan, particularly if the company offers a matching contribution. Most employees are aware of this, but it is important for them to understand why. Regular 401(k) contributions help employees save for retirement while also reducing current taxable income. And the tax savings can be substantial for highly paid professionals. 

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. The exact answer to 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? 

In most cases, 401(k) money is essentially locked up until age 59½, due to a 10% early withdrawal penalty and because 401(k) withdrawals are taxed as ordinary income in the year of withdrawal. Taking money out of 401(k) plans before reaching 59½ can be expensive. As employees build their 401(k) savings, they create a large reserve of illiquid assets, which is necessary for the future but could be problematic if they don’t also have other types of accounts 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 and should be easy to incorporate into employee benefit education. 

Even before saving in a 401(k) plan, most financial advisors 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 could be an option to keep major purchase savings for one to three years until needed, allowing savers to potentially earn a little higher interest rate than with a bank account without investing the money in the volatile stock market. This money needs to be available 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). Whenever possible, it’s important to consider contributing 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 is directed after maxing out tax-deferred vehicles. College savings might be in the mix here as well and 529 educational savings accounts can serve as an avenue for most people. Family priorities guide the amounts saved toward each goal. 

This basic framework for making savings decisions can help employees and doesn’t require a company to provide individual advice. 

Employee Stock Purchase Plan (ESPP) 

Publicly-traded companies frequently offer an employee stock purchase plan (ESPP) as an opportunity for employees to earn more, contribute to the company’s success, and align their 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 potentially earn the built-in investment gain. If employees sell their shares immediately after receiving them, they may capture some or all of the discount. This is another reason employees may want to consider directing some cash flow to ESPPs. 

The rate of return for ESPPs with maximum discount is actually higher than the 15% purchase discount. For example, 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% discount-based gain (before fees, taxes, and any price movement). This example is illustrative only; actual outcomes depend on plan terms, taxes, fees, and stock price movement 

The investment return can potentially increase if the ESPP allows “lookback” pricing where 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 could potentially increase the discount based gain. 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 and employees can often find themselves struggling to understand them. 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 it is likely they are not planning for taxes. 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 may lead 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 employers could package succinctly for today’s ultra-busy workforce. How about a primer about federal and state taxes? Tax law drives most of the complicated features of equity compensation, retirement, and health care plans. 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 be a bad thing, meaning you set your withholdings too high and gave the government an interest-free loan? Not many. This is another area to incorporate useful, sought-after education through benefits workshops without offering individual tax advice. 

The high cost of housing in most tech cities and how to work with it is another area that generates much interest. Employees often want to buy homes and offering seminars about this goal can be valuable. Related 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 can help create a workplace culture of financial competence. Schools don’t usually teach personal finance, so it might be time for private sector companies to help support a workforce that is knowledgeable and more engaged in their work for the company. 

Starting with financial education 

One way to begin is through offering education about how employee benefit programs fit into a comprehensive financial plan. It’s helpful to know not only features of the various benefits offered but also when and how to use which benefits and their tax consequences. To help leadership and staff understand this level of strategy, they can seek the advice of a reputable, experienced financial professional who holds industry credentials like the Certified Financial Planner™ credential and acts as a fiduciary.  

If you’d like to start providing education and resources around various topics, you can 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 in the corporate library and stored on a server or internal website. Younger employees, who typically need the information most, might particularly enjoy the social aspects of lunch-time get-togethers.  

Creating a culture of financial competence adds a new dimension to the employee and employer experience. This can help employees grow and make choices that align with their futures and goals.  

While venturing into personal finance education might not feel like an obvious direction for many companies at first, it can be a valuable resource for everyone. 

This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant. Please consult your investment professional regarding your unique situation.