Why Emergency Savings May Be Staying Out of Plan

Sponsors looking to add an emergency savings account for their participants have two types of ESAs to choose from: pension-linked ESAs and out-of-plan ESAs. Despite the fanfare around PLESAs created from federal legislation, many experts and practitioners agree that though PLESAs have some advantages, their out-of-plan rivals are much more popular with plan sponsors right now.

The idea of a PLESA was relatively simple: provide a tax-privileged savings account that can take advantage of automatic enrollment and employer matching, but unlike a traditional 401(k), be available for short-term needs without tax penalty. The reality of creating that setup, however, has turned out to be more complicated, with out-of-plan emergency saving options more straightforward for both employee and employer.

Advantages of Out-of-Plan ESAs

Out-of-plan ESAs operate similarly to a bank account, says Kendra Isaacson, a principal at Mindset and former Senate pension policy director for Senator Patty Murray. They are tied to payroll deductions and exist outside of any retirement plan the sponsor may offer. They can also exist even in the absence of a retirement plan, which many employers still don’t offer.

Even for employers who have a defined contribution setup, however, simplicity may override all other factors, according to Sid Pailla, CEO of Sunny Day Fund.  

 “We faced a lot of confusion with employees,” when discussing PLESAs and employers wanted “simpler communication and simpler administration,” Pailla says.

He notes that out-of-plan accounts are normally invested like normal bank accounts, or sometimes money-market accounts. Some, though this is not common, can be invested in financial markets, though this is not a service Sunny Day offers because they lose their FDIC insured status, and “trust at the end of day is key” for emergency savings to work.

But, if out-of-plan ESAs are similar to bank accounts, why have one at all when employees should be able to do it on their own?

Pailla says that “a significant chunk of people” are denied bank accounts and opening an ESA is usually easier option for them.

Meanwhile, Devin Miller, CEO of Secure Save, adds that many do not save enough and “there is something about the idea of calling it an emergency savings account and keeping it separate from their checking account” that encourages saving. If people did save enough “we wouldn’t have the savings crisis we have and none of these products would exist,” Miller says, adding that: “it’s like budgeting; everyone knows you should do it, but many don’t prioritize it.”

Miller also agrees with Pailla that the main selling point for out-of-plan options is their relative simplicity. Employers have “a lot of freedom and flexibility in how they offer the program,” Miller says. PLESAs, meanwhile, have more complicated compliance requirements and must be linked to an already existing retirement account.

Pailla of Sunny Day Fund says that “ultimately the market wasn’t quite there for the PLESAs,” and principally for the reason of complexity.

Miller adds that “90% of our employers offer an incentive” for participants to save in their out-of-plan options, which include a sign-up bonus, paycheck match, and milestone incentives. Miller says these usually add up to around $100 to $150 per year and are reported as ordinary W-2 income.

Advantages of PLESAs

There are, of course, advantages to PLESAs that may become more relevant if the underlying defined contribution system makes them simpler to implement.

The savings vehicleswere created by the SECURE 2.0 Act of 2022. They are tied to a defined contribution retirement account and can be made available only to non-highly compensated employees. Employers may automatically enroll employees in them as well and match a participant’s PLESA contributions with employer contributions to their retirement plan.

PLESAs operate similarly to Roth accounts in that they are funded with after-tax money, but the growth is not taxed. The maximum balance a PLESA is $2,500, though interest on those funds may grow over the limit. PLESA funds can also be rolled into a Roth plan or IRA.

Mindset’s Isaacson, who was one of the main architects of this provision in SECURE 2.0, argues that PLESAs can still be more valuable than out of plan options for some sponsors because they are tax privileged as Roth-style accounts, whereas out-of-plan accounts are not, and PLESA contributions can receive matching contributions.

Pailla adds that automatic enrollment in PLESAs is “arguably the most powerful thing about a PLESA,” though he is optimistic that future legislation will allow the same for out-of-plans. He notes, though, that sponsors with an out-of-plan option can still force a decision by structuring their enrollment in a window in such a way that a participant is forced to think about whether they want an ESA, a process he calls “active choice.”

Pailla says that some sponsors will elect PLESAs for their employees for reasons of their own, which can include wanting to match contributions without payroll taxes. However, out-of-plan options “are a reaction to what PLESAs do well,” but without the added complication and compliance risk.