Employer Stock In Your 401(k) Account Can Leverage Your Risks

Depositors and investors aren’t the only people taking a financial beating from the recent collapse of two regional banks. Many bank employees are suffering big losses in their 401(k) accounts.

The Federal Deposit Insurance Corporation took over Silicon Valley Bank and Signature Bank, rendering stock in the banks worthless. The contagion that frequently accompanies bank runs and market panics caused significant declines in the prices of stock in other banks, especially regional banks.

Employees of publicly-traded companies frequently own employer stock in their 401(k) and employee stock ownership plans. About 19% of the assets in the SVB retirement plans were in the company’s stock, according to Pension & Investments. It’s not unusual for that much or more of bank employee retirement plans to be allocated to company stock, according to data published by P&I.

Employers used to encourage or even require employees to invest a portion of their 401(k)s and other retirement plans in company stock. Many employers reduced their emphasis on owning company stock over the years, primarily because bankruptcies and significant stock price declines made the employers and some officers potentially liable for losses in employee retirement accounts.

In 1997, about 30.6% of 401(k) plan assets were allocated to company stock. The allocation to company stock fell to 6.2% at the close of 2022, according to the Alight Solution 401(k) Index.

Allocating a significant portion of one’s retirement savings to the employer’s stock can be risky, as shown by the collapse of SVB and Signature Bank.

Individuals have both human capital and financial capital. Human capital basically is your ability to earn income from employment or self-employment. Financial capital is the portion of those earnings you save and invest.

One risk of human capital is that the employer does poorly or even fails. That reduces your earnings at least until you find a new job. The damage to human capital might be permanent if you can’t find a job that pays a comparable amount or the problems at the first employer damage your marketability.

The risks are compounded when a significant portion of your retirement savings are invested in the employer stock. Then, both your human capital and investment capital depend on the success of the employer and are at risk if the employer falters. Employees could simultaneously lose their jobs and see significant declines in their financial capital.

Concentrating retirement savings in one stock is risky, even when you aren’t an employee of the company.

Concentrated investing could substantially increase returns when the stock turns out to be a market leader. Some people benefited in recent years by focusing their portfolios on a few stocks that turned out to be big winners, such as Apple, Amazon, Google, and Tesla.

But concentrated investing makes a portfolio more volatile. Also, an investor can’t know everything happening inside a company and all the forces to which its stock is vulnerable. Some investors who concentrated in a few big winners were happy until the stocks lost 50% or more of their values in 2022.

Keep in mind that when you own both company stock and mutual funds in a 401(k) account, the mutual funds might also own shares of your employer.

Some people are more confident when they own their employers’ stock in retirement accounts. They believe that as employees they have good insight into how the company is doing and will know if it is time to sell.

But the opposite is more likely to be true. Employees with significant allocations to employer stock in their 401(k) plans tend to have lower investment returns than others, according to 2013 research by David Blanchett. Also, companies whose 401(k) plans have significant allocations to the employers’ stock tend to have poorer stock performance than other companies.

My father worked for AT&T for many years. He took advantage of incentives the company offered to directly purchase shares of AT&T stock. He still owned shares when he passed away, as well as shares of its spinoffs and successors.

But those shares were a small portion of his net worth. Most of his savings were in investments unrelated to AT&T. In addition, when he worked there, AT&T was a regulated utility monopoly and the stock paid a high dividend. It was a much safer stock than its successors, and the company’s core business also was low risk.

Most of us have heard stories of people who retired early or very well off because they worked at companies with outstanding stock performance and invested in a lot of company stock while working there. But those instances are rare. It’s more likely a former employee benefited from stock options than from buying employer stock in a 401(k) account.

There are more cases of people being hurt badly by losing both their jobs and a substantial part of their investment capital because they bet their future on one company.

Owning employer stock has benefits. But employees must be aware of the risks and should avoid risking their financial security on one company. A good rule of thumb is to limit investment exposure to an employer to 5% to 10% of one’s financial capital.

Sometimes you almost have to own some employer stock, because 401(k) matching contributions are paid in employer stock or the employer offers stock purchase discounts that are too good to pass up. In those cases, monitor the percentage of net worth that’s in employer stock and sell some shares when the allocation is too large.

Before selling shares, however, take a look at the tax rules for sales of company stock in retirement plans, known as net unrealized appreciation rules. You might receive a substantial tax break based on how the sales are handled. It’s often worth consulting with a tax advisor to determine if you can benefit from the NUA rules.