The world is likely to be quite different after the coronavirus pandemic. We may find ourselves greeting other people with elbow bumps, working from home more regularly, and having a whole new appreciation for emergency fund savings accounts.
Prior to the coronavirus crisis, relatively few Americans had enough liquid assets set aside to cover three months of expenses. A September 2019 report from the Federal Reserve’s Survey of Consumer Finances stated that just one-in-five families with a head of household younger than age 65 had assets equal to three months of income set aside for emergencies, like a job loss, an economic downturn, or a severe illness.
The COVID-19 pandemic may produce a new perspective on the critical importance of emergency savings. A mid-March 2020 survey from Parents Together reported:
“Families are already struggling as a result of the rapidly spreading economic fallout from the measures implemented to slow the spread of the novel coronavirus: 80% of respondents are worried about having enough money to cover basic housing and food costs within three months. 46% are worried about running out of money within the next two weeks.”
The crisis also may reinforce a damaging belief that retirement savings and emergency savings are the same thing.
Prior to the crisis, a significant proportion of retirement plan participants (49%) planned to use their retirement savings for non-retirement expenses, including emergencies, according to a report authored by Catherine Harvey of the AARP Public Policy Institute.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was signed in to law by President Trump on March 27, 2020, provides financial relief to individuals and businesses across the United States, included provisions that modify in-service distribution restrictions. The CARES Act:
- Creates a temporary hardship withdrawal option that defined contribution plan sponsors may adopt. It allows participants who are negatively impacted by the coronavirus to take a ‘coronavirus-related distribution’ of up to $100,000 anytime during 2020. The distribution is not subject to penalties or withholding taxes. Income taxes will be owed on the distribution and may be paid over three years.
- Increases the maximum plan loan amount from $50,000 to $100,000 for loans taken between March 27, 2020 and September 23, 2020; delays the due date for loan repayments for qualified individuals that are due between March 27, 2020 and December 31, 2020 for 1 year; and extends the maximum 5-year repayment period accordingly. The new legislation also changes the rules so that participants can borrow up to 100% of their vested account balances.
There is no question about the need to address economic hardships created by the pandemic. However, the steps taken to alleviate immediate financial needs are likely to exacerbate the retirement crisis. A 37-year-old who takes a $30,000 distribution to keep a family afloat in this time of crisis has also greatly reduced his or her retirement nest egg. Over 30 years, that $30,000 could have been worth more due to compound interest.
Emergency savings protect retirement savings
When the disease curve flattens and the United States begins to right itself, adding an emergency saving fund option to your company’s financial wellness program will signal to your employees that you understand the financial aspects of the crisis and want to help them avoid experiencing similar hardships in the future.
Establishing a payroll deduction emergency savings fund option and educating employees about emergency savings, employers can help protect employees’ retirement savings. Offering two distinct accounts and clearly labeling their uses – ‘emergencies’ for one and ‘retirement’ for the other – can help participants think differently about the money they have saved. According to behavioral economists, when people understand the origin and intended use of savings, they may be reluctant to use the money for other purposes.
Structuring an emergency savings plan
There are many ways to structure emergency savings programs, and the choice that suits one employer may not be right for another. The structure your company chooses will depend on corporate culture, employee demographics, and benefits objectives. Some of the options to consider include:
- Payroll deduction emergency savings. Employees can direct a portion of their pay to emergency savings fund accounts, which they have opened at banks, credit unions, or other financial institutions. Payroll deduction savings fund accounts may be advantageous because they are designed for short-term saving, controlled by employees, and covered by FDIC insurance.
One drawback is that employers have few ways to incentivize participants to keep the savings for emergencies.
- Payroll deduction Roth IRA accounts. Employees can direct a portion of their pay to Roth IRA accounts that employees have opened at financial institutions. Implementing and administering payroll deduction Roth IRAs is relatively straightforward. The accounts may be advantageous because they offer tax-advantages, are controlled by employees, and stay with employees when they change jobs.
Roth IRA contributions can be distributed tax-free and penalty-free five years from January 1 of the year in which the first contribution is made (referred to as the “5-year rule”). However, any early withdrawal may subject earnings to withdrawal penalties and taxes, unless certain requirements are met. The tax friction could prevent employees from using the assets for non-emergencies.
- Voluntary after-tax employee contribution accounts. Plan participants make voluntary after-tax plan contributions to accounts within 401(k) plans. Voluntary after-tax accounts already are accounted for separately within retirement plans. The option may add administrative and fiduciary complexity; however, it also may allow for automatic enrollment and matching contributions.
This option is similar to Roth IRAs in that any pre-tax earnings distributed may be subject to taxes and penalties. However, with after-tax accounts, any earnings must be distributed as part of a withdrawal.
The coronavirus crisis has created an unparalleled financial disruption in the United States. It’s likely that some Americans will return to work with higher levels of financial anxiety, and many will have a strong desire to build a financial bulwark. Offering an emergency savings fund option that does just that will help them gain or renew financial confidence.
Kevin Clark is senior vice president and business development director of Retirement Services at Millennium Trust Company, LLC. Mr. Clark has over 30 years of experience with employee benefits and retirement services. Millennium Trust Company performs the duties of a directed custodian, and as such does not offer or sell investments or provide investment, legal or tax advice.
