Coming up with the cash to cover an unexpected emergency expense can be a challenge for many individuals and families.
Studies show an unexpected expense of even $400 may prompt people to borrow to cover the cost. When faced with such bills, workers may be tempted to tap their retirement savings accounts.
Now, new provisions in retirement legislation called Secure 2.0 moving forward on Capitol Hill would make it easier for workers to set aside emergency funds.
The first change would make it so retirement plan sponsors could automatically enroll employees to set aside up to $2,500 of post-tax money in a separate emergency savings alongside their retirement accounts. Workers could defer money to the emergency savings accounts automatically through their payroll deduction.
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The second change would allow retirement plan participants to withdraw up to $1,000 from their retirement savings per calendar year to cover emergency expenses without incurring a penalty. However, the borrower would have to replace those funds within the following three years before making another similar withdrawal.
Notably, a plan for separate standalone emergency savings accounts outside of retirement plans did not make it into the legislation. That could have helped the nearly 50 million workers who do not have access to retirement plans through their employer, said Shai Akabas, director of economic policy at the Bipartisan Policy Center.
“I am cautiously optimistic that in the next year or two that that could pass on some other legislation that would allow for employers to set this up separate and apart from the retirement plan as well,” Akabas said.
Still, the emergency savings changes, particularly the $2,500 sidecar accounts, could make a big difference, he said, following efforts that began in 2016 with a Bipartisan Policy Center retirement commission and a subsequent proposal from Sens. Cory Booker, D-N.J., and Todd Young, R-Ind.
“There needs to be more attention paid to the emergency savings challenges in this country and more tools given to rank-and-file Americans,” Young said on a recent Bipartisan Policy Center panel.
While some companies have already begun to test out emergency savings plans for employees, a key difference is this legislation will give them the ability to automatically enroll participants, Akabas noted.
Without dedicated emergency funds, individuals often turn to their retirement accounts when they face a cash shortfall, which can lead to the unravelling of their financial security.
In the aftermath of the Covid-19 pandemic, Congress made those retirement assets more accessible, which was a wake-up call as to how much people tend to lean on their retirement plans when they are financially pinched, according to Jeff Cimini, head of retirement product at Voya Financial.
“They just took a lot more than we ever expected,” Cimini said.
As high inflation has raised the cost of living, retirement savers are still turning to their retirement accounts to help cover cash shortfalls. Recent data from Vanguard Group showed the share of retirement savers who withdrew from their 401(k)s to cover financial hardships hit a record high in October.
Without solving the short-term savings shortfall, it will be impossible to resolve long-term retirement savings needs, Cimini said.
“Voya is hugely supportive of the establishment of an emergency savings option within the context of a retirement plan,” Cimini said.
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The combination of a retirement account with an emergency fund can help communicate to employees that they need to set aside funds for both their short- and long-term needs. Once they do, their retirement funds will not be the first place they withdraw from.
“We’re very optimistic that this will really have a big impact on long-term retirement security for the U.S. labor force,” Cimini said.
Larger plan sponsors will probably lead the way with adoption of these provisions, Cimini predicted.
Companies have already begun experimenting with emergency savings benefits. Investment firm BlackRock has created a philanthropic Emergency Savings Initiative that has tested offerings with companies like payroll services company ADP and consumer electronics retailer Best Buy.
Personal finance expert Suze Orman has co-founded fintech company SecureSave that enables employers to set up emergency funds for employees that include automatic contributions and matches.
“Employers need to get involved in this, because most people won’t save money unless their employer somehow does it for them through a payroll deduction,” Orman said at a recent Bipartisan Policy Center panel.
The proposed Secure 2.0 changes are a big acknowledgement from Congress that change is needed, said Timothy Flacke, co-founder and executive director of Commonwealth, a nonprofit focused on building financial security for vulnerable populations that is working with BlackRock’s initiative.
“Congress has essentially said that short-term financial security matters,” Flacke said. “And that in and of itself is a really big deal.”
The changes may not mean everyone will suddenly have ample emergency savings, he said. But they will make having money set aside much more possible for people, which is a great start.
“There are real people out there who will confront very real, very high-cost, very painful financial emergencies who are much more likely now to have a few hundred bucks of their own money that they can draw,” Flacke said.