Same Career, Very Different Results

July 20, 2021

By Daniel Cohen

I have advised many corporate executives at various stages of their careers. Some make all the right decisions related to their personal financial planning and consequently accumulate significant wealth. Some will avoid making important decisions or forego available corporate benefits and miss out on some great opportunities to save and invest.

Corporate benefits come in the form of a match, bonus contribution to a plan, or a discount on the cost of an investment.  Other benefits can include a current or future tax savings. Working with a Certified Financial Planner experienced in corporate benefits and tax strategies serves executives well, especially those who work for publicly traded companies and firms that offer equity participation to employees.

Imagine that Jane goes to work out of college and takes the time to educate herself on personal financial planning and wants to maximize her financial position.  At the same time, John goes to work but does not worry about his financial plan and figures he isn’t making enough yet give his finances much thought or planning. Jane understands time value of money, the power of compounding and the benefits of dollar cost averaging. She learns that stocks have outperformed other investments over long-periods of time despite the periodic corrections and daily volatility. In addition, Jane recognizes that taxes are now one of her biggest expenses, and she needs to consider the impact taxes have on her financial life. John figures he will worry about these things later in life after he is more established in his career.

A Tale of Two Professionals

Jane and John both work in similar positions at the same publicly traded company which offers all employees a 401(k) plan with a 4% company match. The plan allows for traditional pre-tax contributions or Roth contributions. It also allows for post-tax contributions beyond the annual limits of $19,500 for those under age 50 and $26,000 for those over age 50. This plan even allows for in-plan conversions from the pre-tax or post-tax account to the Roth account. Additionally, the company offers a Health Savings Account. On top of that, the firm offers an Employee Stock Purchase Plan with a 15% discount on the price of the company shares. Ironically, so many options can overwhelm people into putting off decisions or doing nothing.

Jane knows that if she doesn’t contribute to the 401(k) she doesn’t get the match. If the average college graduate makes $50,000 annually and the invested income grows 5% per year, the match in a 401(k) can add up to a significant sum over a 30 year career. If the ongoing match in the retirement plan earns 7%, that account alone could compound to about $350,000 in 30 years starting with $50,000 of earnings. Of course, that wage income would likely increase over the years with raises and promotions.

John heard about the match but isn’t worrying about retirement at his young age. If he waits five years and then starts contributing to get the match, the compounded value of his account would be about $60,000 less than Jane’s at the same time. Jane’s decision to save 5% of her income from day one on the job, provided her with significantly more money in savings.

Participating in an Employee Stock Purchase Plan, ESPP, is similar to the 401(k) decision just described. If you participate, you get the additional savings. If you don’t, you lose that opportunity.

A little now can mean a lot later!

I’ve advised many people with access to ESPP plans and fewer take advantage of this benefit than do the 401(k). The benefit amount is generally less than a 401(k) match at lower income levels but an investment in an ESPP does not need to be deferred for 30 or more years until retirement. If Jane and John’s employer offers a 15% discount on their shares and allows employees to invest up to 10% of their pay into the plan, it would provide an initial $750 bonus assuming the share price does not change during the year. Jane gladly participates to get this bonus but John won’t bother for that small amount. What John doesn’t realize is this $750 discount bonus earning 7% and increasing with pay raises could grow to well over $132,000 if compounded during a 30 year career.

Share prices can go down but if they appreciate during the year, the ESPP gain would be bigger. ESPPs only require employees to hold the shares for six month or a year so young employees who might need cash for something down the road can participate without tying up the funds too long.

We see by these examples that making informed decisions now can make a big difference over the course of a long-term period such as a career span. There are many other investment, tax strategies and savings opportunities that should be explored to create the optimal financial plan.

Unravelling Complexities

Some savings plans depend on the benefits offered by an employer while many others are unrelated. For employees, it’s not enough just to participate in their company 401(k). Employers’ savings plans often have dozens of investment choices within the plan that should be strategically chosen.

Someone investing in stock funds will likely accumulate more than someone investing in stable value funds over a 30-year career. Then, there are tax strategies that need careful consideration. Sometimes paying taxes on money contributed to a plan now rather than paying them later can allow for tax-free compounding that can have a highly positive impact in retirement. Just as eating right should be a healthy lifestyle decision, participating in available savings plans and investment opportunities is essential to long term financial health.

The ideal financial plan starts as early as possible. Some young people even start saving money in tax advantaged accounts from summer jobs earnings and allow those contributions to compound over many decades. Courses on financial planning can be greatly beneficial to young investors, and seeking the advice of a Certified Financial Planner is highly recommended.

This article’s story, along with its characters Jane and John, are fictional. However, the mistakes and lack of planning represented in John’s case are all too common. As a Certified Financial Planner, I see it all the time. Our job is to help our clients plan a better future. Knowing everything about their financial history and present situation enables us to optimize their investments and savings plans.

After 25 years of financial planning experience and seeing repeated patterns, we can share the knowledge with others facing similar situations. Better financial plans stem from knowing the common mistakes to avoid and the time-tested principles to embrace.

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