Foul Weather Fund

A lack of emergency savings is a major financial worry—second only to inadequate retirement savings, according to the 2019 John Hancock Financial Stress Survey: 25% of study participants had no emergency savings at all. Employers often can sense the financial stress in less productive employees and see it in increased 401(k) plan loans, says Brian Nelson Ford, a financial well-being executive at SunTrust Banks Inc. in Atlanta.

Employers increasingly understand why it makes sense for them to play a role in their workers saving for emergencies, Ford says. But with little federal regulatory guidance and no clear best practices emerging in these early days of employer involvement, employers have a wide set of options to consider. “It’s a little bit like the Wild West now,” he says. Everyone has good intentions, but there is much variety in the approaches being utilized, he says.

Emergency savings has become a regular conversation topic at many plan committee meetings, says Harry Dalessio, head of institutional retirement plan services with Prudential Retirement in Hartford, Connecticut. For plan advisers, he says, it is worth starting now to take on the role of emergency-savings advocate and consultant: They can help an employer decide on its emergency-savings philosophy and pick the program that best suits its goals; work on the design and implementation of a program; help a sponsor decide which investments to utilize for the program; and educate participants about why they should save for emergencies.

Taking Care of Short-Term Emergencies

Three-quarters (75.3%) of households headed by defined contribution (DC) plan participants have liquid savings equal to three or fewer months of their income, according to an Employee Benefit Research Institute (EBRI) analysis of Federal Reserve data. “These people probably will not be able to cover their expenses if they have an emergency,” says Craig Copeland, senior research associate at EBRI, in Washington, D.C. “If they build up debt to pay the emergency expenses, they’re going to focus on paying that off, instead of saving for retirement. Or they’ll take the money from their 401(k) account to pay those expenses.”

Almost 20% of large employers—those with 500 or more employees—now offer some type of help with emergency savings, an EBRI survey found. “What we see, more and more, is that if people can take care of their short-term emergencies financially, they’re better able to save for their retirement,” Copeland says.

When they do save, Americans most often save for their retirement, because of the ease of doing so through their employer plan, Copeland says. “It tends to be the dominant way of saving for Americans, because the money comes directly out of their paycheck.” He says, similarly, using payroll deductions for emergency savings could help Americans build up a second savings bucket.

Here, experts discuss three main models for emergency savings that, at least in part, could be implemented by employers:

1. Rainy-day savings account within a 401(k). According to Prosperity Now, a nonprofit research and advocacy group that detailed the three models in a recent paper, employees may create an emergency savings account within their 401(k) account. Using this approach, they can make both pre-tax and after-tax elective contributions under the same 401(k) plan umbrella, says the paper, “Saving for Now and Saving for Later.” After-tax contributions accumulate earnings on a tax-deferred basis, and an amount equal to the employee’s contributions may be withdrawn free of taxes or penalties. An employee’s pre-tax contributions would be separate and function as part of the traditional 401(k).

Prudential Retirement currently is testing the concept of an emergency savings account within a 401(k) plan. “We started our pilot program in mid-2018, with 15 clients,” Dalessio says. “We’ll bring another 10 to 20 clients online in the program in the next few months.”

Because many state wage-withholding laws limit an employer’s ability to automatically enroll employees into after-tax savings, employees need to sign up for the emergency savings feature, Dalessio says. With this approach, a 401(k) account has both a short-term focus (emergency savings) and a long-term focus (retirement savings); both have fiduciary oversight. “The idea is that employees can go to one place to save, with a payroll deduction. We felt this is a very simple solution, and people want simple.”

Prudential hopes that incorporating emergency savings into a 401(k) plan will help reduce leakage. “We are trying to minimize people tapping into their retirement savings for other issues,” Dalessio says. “For most people, that’s where their money is, and that’s where they go when they have an emergency. The thinking is that if they have money in their plan earmarked for emergencies, they’ll be less likely to take a loan or hardship withdrawal.”

Account holders may withdraw the money in their after-tax emergency savings account for any reason, Dalessio says; it need not be used for emergencies. “Part of the education program will be about having this source of money geared for emergencies. But the expectation is that the money is there to be used, not built up.”

The paper from Prosperity Now, which collaborated with Prudential on developing its pilot program, says this approach has several potential benefits. These include the logistical ease, compared with the other two models, for employers that already sponsor a retirement plan, because employees will not need a new account. It is also relatively simple for providers that already facilitate after-tax contributions.

Plus this approach simplifies emergency saving for employees, says David Newville, Prosperity Now’s vice president, policy and research, in an interview. “The predominant way most Americans save is through their employer’s retirement plan,” he says. “The money comes out of their paycheck, and they can kind of forget about it.”

2. Rainy-day savings account alongside a 401(k). In the second approach, the emergency account is a Roth sidecar individual retirement account (IRA)—aka a deemed IRA—repurposed for emergency saving. These accounts are owned by workers participating in an employer-sponsored plan and are essentially attached to and offered through it. The account retains the character of an IRA but can have economies of scale through commingled investment with the employer plan, which is potentially cheaper for participants.

“The option that is the easiest for employers is likely the after-tax savings account feature that, in many cases, was set up by employers before the 401(k) even started,” says David John, senior strategic policy adviser at the AARP Public Policy Institute in Washington, D.C. “It’s fairly easy to repurpose those as emergency savings accounts if the plan documents allow for it.” And if not, he says, it is simple to change the plan documents to do so.

“It’s an interesting idea and certainly worth employers experimenting with,” says George Barany, America Saves director at the Consumer Federation of America, also in Washington, of having an inside-the-plan IRA earmarked for emergency savings. “One size doesn’t fit all, and we need to explore multiple opportunities for emergency saving.”

3. Rainy-day savings account separate from a 401(k). The third model is a rainy-day savings account independent from a 401(k). This approach could take the form of a traditional individual savings account, or a reloadable prepaid or payroll card tied to an account administered by a bank, credit union or payroll-card provider retained by the employer, according to the Prosperity Now paper, which notes that a number of employers and third-party financial providers are currently implementing some form of this approach.

Below are a few companies that have devised a ­separately operating rainy-day savings program and either have already or plan to make these available:

• SunTrust. SunTrust includes an emergency savings component as part of its financial wellness program, Momentum onUp, which more than 200 employers have utilized. The program puts emergency savings into the context of a more holistic program to improve the participant’s confidence about his finances and includes both emergency savings tools and education, Ford says. “People do need emergency savings tools, but they also need education. I worry that if there’s too much conversation about tools, it can leave out education.” In SunTrust’s program, employees set up an emergency account themselves, and the employer can facilitate payroll deductions to it.

SunTrust also uses the program to benefit its own employees. Employees who complete the program and set up a SunTrust emergency savings account get a $1,000 employer contribution to it. “They need to put in at least $100 to begin and at least $20 from each paycheck after that,” Ford says. They get $600 of the contribution after the first six months of the program and the other $400 after the next six months. “Our goal is that, within a couple of years, we’ll help get them to $2,000 in their emergency savings account,” he says.

• AARP. AARP is developing an emergency savings program to offer employers and hopes to do a trial run within the next year or so, John says. He describes the model that AARP envisions as using automatic enrollment and a payroll deduction, with an employee’s contributions going into a bank account in his name. “The employer could automatically enroll an employee into two different accounts: the retirement plan account and an emergency savings account,” he says. “The employee would have a bank card, just like an ATM card, and could withdraw the emergency savings money whenever he wants, for anything.”

• Split to Save. Barany likens this Consumer Federation of America program to a “plug and play” scenario for employers. An employer signs up for the free program, and then its employees can access the program’s website, in five minutes setting up their participation. “It asks them to make a pledge to save,” he says. “People identify a goal of their choice, how much they want to accumulate, and how much they think they could save monthly.” That monthly savings goal, once the employee OKs it, will become a payroll deduction; the money goes into a savings account he sets up for that purpose.

“The idea is people have split accounts: One is for spending and one is for saving,” Barany says. “My employer could put the majority of my pay into my checking account and then the small amount that I want into my savings.”

• SafetyNet. The Cookie Jar program from SafetyNet Insurance Agency LLC aims to help people get started with small-dollar savings, says Roshni Chowdhry, head of customer experience for the company, in Madison, Wisconsin. “Our goal is to help people [save] in a painless fashion.” A consumer using the program can create specific goals to automatically save to, within his Cookie Jar savings account.

Cookie Jar rounds up any checking account and credit card transactions that a participant performs to the next-highest dollar amount, then the program’s platform facilitates direct depositing that difference into the person’s emergency account. A $9.01 transaction becomes $10, with 99 cents contributed to emergency savings. “The account holder can access the money at any time,” Chowdhry says. “There’s no limitation or penalty for withdrawals.”

The default for new participants is a $50 savings goal, and they can change it, Chowdhry notes. “Starting with a modest amount gives people hope: ‘Oh, I can do that.’ And before they know it, their accounts add up quickly.” Users now elect to direct deposit into a savings account they set up, but the company hopes to be able to integrate with payroll systems for payroll deductions, she says. “That’s our vision, to make this as much of a no-brainer for people as possible.”

Employers using the program can match percentage of their employees’ deferrals monthly, such as 50% of an employee’s contribution, up to $50 a month.

The Outlook

It is too early to know which approaches to emergency saving get better results, Newville says. “People look at the three models and ask, which is best? Right now we’re in a place where people want to rush to pick something out,” he says. “But the providers need to take the time to pilot the programs and see what these programs do to help employees.”

Currently, employer-based emergency savings programs do have some legal/regulatory uncertainties, John says. For a program inside a 401(k), those include how enrolling employees into the savings feature will affect a plan’s nondiscrimination testing and how participants will get taxed on their emergency savings’ investment earnings when they make withdrawals. “These are things that could be dealt with fairly easily by regulatory or legislative fixes,” he says. “None of these issues are insurmountable. It’s just that we’re trying to use a retirement-savings mechanism for a slightly different purpose.”

Ford predicts that in the next several years, the federal government will supply more ground rules for such employer-based programs. “I do believe that formalizing these programs, as we have with retirement plans, is a good thing. The ERISA [Employee Retirement Income Security Act] law is great for a 401(k), but it wasn’t set up for emergency savings,” he says. “I’d like to see the government provide more clarity for employers. If that happens, I think we’ll see a revolution in emergency saving in America.”

Dalessio stresses that advisers should “get involved in this, because employers’ needs are getting broader. Historically, the retirement industry has been focused on its silo: We looked at our vertical market in totality. But now, the conversation with employers is getting bigger: All the pieces [of employees’ financial lives] are coming together. The winners in the plan advisory space will expand the breadth of the capabilities they provide to clients beyond the 401(k) and evolve to more of a financial wellness platform.”

Art by Victo Ngai