Improving Financial Security Through Emergency Savings

The bipartisan “SECURE 2.0” legislation contains a provision that facilitates convenient and affordable access to workplace short-term savings accounts that would improve financial security by promoting emergency savings and reducing retirement account leakage.

Issue

Americans need to increase their personal savings so that they are better positioned to handle emergencies and major purchases, as nearly 40% report they would struggle to cover an unplanned $400 expense. Most workers have the option to put aside savings in a bank account of their own, but for various reasons are constrained to do so. Insufficient short-term savings can lead households to draw down their retirement savings prematurely and, in turn, incur costly taxes and penalties. While dipping into retirement savings might help address an immediate financial squeeze, it jeopardizes long-term financial security as Americans plan for retirement.

Solution

Payroll-deduction emergency savings can provide relief. As a workplace benefit, these plans allow employees to select a portion of each paycheck to deposit into an emergency account, similar to and alongside their 401(k) or 403(b) election. But these accounts allow workers to access the funds quickly and penalty-free at any time. Some employers have already begun offering short-term savings accounts on an opt-in basis, but participation remains low.

Given the power of automatic enrollment in workplace retirement savings plans—which has shown to dramatically increase plan participation—lawmakers have an opportunity to replicate this successful policy to help workers save for short-term emergencies. Clearing barriers that have prevented employers from automatically enrolling their employees in these accounts provides an avenue for businesses to build financial resiliency within their workforce and help more American households prepare for the unexpected.

Policy

• Provides retirement plan sponsors (e.g., employers) the option to automatically enroll their workers into after-tax pension-linked emergency savings accounts (PLESAs) that reside alongside their tax-advantaged retirement account.
• Allows for automatic enrollment by clarifying rules around state wage garnishment laws, Know Your Customer requirements, and default investments.
• Plan sponsors could automatically enroll workers at up to 3% of pay, with the option for participants to adjust their contributions at any time.
• Employees can always opt out or withdraw their funds from the PLESA penalty-free and tax-free. Withdrawals must be permitted at least once a month, and the first four withdrawals per year must be offered fee-free.
• PLESAs have no minimum balance requirements and a limit on contributions once the balance reaches $2,500, after which contributions would pause or be invested in a Roth (after-tax) retirement savings plan, bolstering retirement security. Plan sponsors could set lower maximum account balances.
• Employee contributions (up to the maximum account balance on an annual basis) are considered elective deferrals for the purposes of retirement matching contributions, meaning that employees who are only able to save for emergencies would still benefit from their employer’s match. This also means that increased participation in emergency savings plans would help employers with their 401(k) non-discrimination testing.
• At the discretion of the plan sponsor, funds can either go into a simple interest-bearing account or an investment that prioritizes principal protection. Investment flexibility and account growth are not the purpose of these accounts.
• When switching jobs, participants can cash out their PLESA or roll it into a Roth defined contribution account or a Roth IRA. This would encourage additional retirement savings and reduce leakage out of emergency savings accounts.
• PLESAs are covered by a modified version of ERISA regulations with fewer requirements.