Over the next 40 years, employees will sacrifice approximately $8.5 trillion in retirement wealth and $50 billion in retirement income simply because of not claiming the correct number of exemptions.

Helping your employees become financially healthy requires helping them take many small steps toward financial wellness.

As we're fresh from tax season, it's worth reminding employees that a small step they can take toward financial security is not overpaying their federal and state withholding taxes. This problem has become even more serious with many states in severe deficit and planning to delay their tax refunds.

Employer withholding is the tax that employers deduct and withhold from employees' wage every pay period. It's based on an employee's wage and number of claimed dependents. Employers withhold both federal and state taxes.

When it comes time to pay taxes, if an employee has withholdings greater than their owed taxes they receive a tax refund. If an employee's withholdings are less than they owe in taxes then the employee owes more in taxes. Ideally, an employee should have withheld an amount of money exactly equal to their owed tax bills.

Unfortunately, the average employee misses this mark by a wide margin and foregoes significiant amounts of potential future wealth and income.

The average federal tax refund in 2008 was close to $2,500. State refunds also are positive. For example, in Massachussets in 2009, the average state income tax refund was $468. In California in 2009, combined federal and state tax refunds averaged close to $3,500.

Fun calculation

Here's a fun calculation to consider. Assume you get your employees to take the right amount of withholding by claiming their proper number of dependents. Let's work with the California number of $3,500 per year.

If your employees, instead of making cheap loans (zero interest rate) to the federal government and their state government, invested this money in a diversified portfolio that earned 7% a year, how much wealth would they have after 40 years? How much income would this wealth generate?

At a 7% rate of return, an employee loses about $245 a year by waiting for their tax refund ($3,500 x 7%). If for 40 years an employee invested this additional money each year, in 40 years' time they would have around $56,000. Assuming this money is then invested and earns 4% over 30 years, $3,113.93 can be withdrawn each year until a zero balance is reached.

Now, contemplate these ridiculously large numbers. In 2008, there were 154,345,853 individual returns filed. Multiplying this number by $56,000 gives us lost wealth of over $8.5 trillion. Multiplying the number of returns filed by $3,113.93 gives us lost yearly income of close to $50 billion. All of these losses for just declaring the wrong number of exemptions.

Communicate this

HR/benefits pros need to communicate the following facts about withholding to help employees select the correct number of exemptions:

* Claim too many exemptions and you'll end up paying more federal and state taxes at the end of the year.

* Claim too few exemptions and you'll end up lending money to the federal and state governments. Long-term, this will cost the average employee tens of thousands of dollars of lost wealth and close to $100,000 in lost income ($3,113.93 x 30).

* Target the number of exemptions such that money witheld equals your tax bill. Employees should try to be neither a lender nor a borrower from government due to withholding errors.

* If an employee receives tax refunds this year, s/he should decrease their exemptions for next year. If this year an employee has to pay taxes over their withholdings then s/he should increase their exemptions for next year.

* If during the year an employee marries or divorces, has a child or has a change of status in dependents, he or she should complete a new W-4 form to reflect the changes.

* Tell your employees to keep away from refund anticipation loans. These are a bad deal that reduce refunds.

* If an employee has their refund check routed to their bank account it speeds up the refund process.

There's one other excellent reason to harp on employees about overpaying on their withholdings: many states are in financial crisis and this might cause some of them to delay their refund checks. Forty-three states withhold taxes on individuals (New Hampshire and Tennessee only withhold tax dividends and interest income).

The seven states that don't have a state tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Because of the current economic crisis, many state budgets are a mess.

It's been reported that close to a half dozen states are considering freezing refunds for as long as five months. States included in this list are Alabama, Idaho, Kansas, North Carolina and New York. State financial problems are only forecasted to get worse in the future.

Contributing Editor Mark Nadler is an economist and professor at Ashland University in Ashland, Ohio. He is a member of The Financial Education Co. and president of Vincuro, a financial stress reduction firm.

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