Do yourself a favor and avoid highly promoted financial wellness “solutions”—emergency savings sidecar accounts and pay-to-date applications. Instead, update your 401k plan’s liquidity features to 21st Century functionality.
Emergency savings sidecar accounts
Should The Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg Act of 2022 (“Rise & Shine) become law, Section 202 will authorize employers to offer “pension-linked emergency savings accounts.”
Employers may automatically enroll employees at no more than 3% of their salary, post-tax, capped to a maximum of $2,500. Such contributions can be treated as elective deferrals for retirement matching contribution purposes.
Such accounts would be suboptimal—in terms of liquidity and retirement preparation. Most Americans live paycheck to paycheck.[i] Over 40% confirm that they have not set aside monies for emergencies.[ii] Those who need to save for emergencies are likely the same workers who do not participate in their employer-sponsored plan or who fail to contribute enough to obtain the full employer financial support.[iii]
Emergency savings would not qualify for tax preferences (pre-tax or Roth). Investments will likely be limited to capital preservation investments. Earnings are probably immediately taxable as regular income. Liquidity is available only as a withdrawal. Perhaps many will not voluntarily replenish the emergency account after each use.
The superior alternative in terms of retirement preparation and minimizing leakage is for plan sponsors and their service providers to eliminate hardship withdrawals and update plan loan processing to 21st Century functionality (electronic banking, a line-of-credit structure, behavioral economics prompts/features, etc.)[iv]
Here’s a side-by-side illustration of a sidecar account, a hardship withdrawal, and a plan loan:
Effective behavioral economics features might include a loan application process that requires participants to complete a loan application that:
- Confirms they considered other liquidity options,
- Confirms they have a backup source of liquidity,
- Includes a “commitment bond” acknowledging repayment is required regardless of any change in employment status (that payments will continue via electronic banking post-separation), and
- Requires participants to execute the application as both the borrower and the lender (future self).
Pay-to-date apps
The same American Payroll Association survey also confirms that nearly 25% of survey respondents already have access to a pay-to-date application or would be interested in such a feature.
This, too, is likely to be self-defeating.
A recent study suggests higher payment frequency reflects higher spending rates and less saving. Studies suggest higher payment frequencies change consumers’ subjective wealth perceptions by reducing uncertainty on whether they will have sufficient resources throughout a period. Payroll frequency impacts financial perceptions, behaviors, and general well-being.[v]
Everyday financial capability is a subjective assessment of the sufficiency of financial resources relative to a benchmark, typically one’s spending needs. Payroll frequency/access reduces consumers’ uncertainty, while consumers with higher prediction uncertainty may safeguard their financial resources—just in case they need more.
If improving financial wellness or financial resiliency is the goal, you may want to avoid the pay apps and emergency accounts—features that may enable workers to continue suboptimal financial behaviors, including chronic spending above regular income.
Who wants to provide a cushion that would allow a worker to delay behavior changes that would improve financial wellness, reduce financial stress, and potentially improve productivity? Who wants workers to remain mired behind the “payday-to-payday” curve? And, if reported studies are accurate, that on-demand pay apps have reduced turnover by up to 30%, are those financially insecure workers who must rely, over and over, on this form of liquidity, really a desired group of workers?
Instead, you should consider implementing a financial intervention as necessary for every new hire—at the same time, you invest in recruiting, onboarding (including auto-enrollment in the 401k, and training. If successful, perhaps the next step to consider is the value of a back sweep of auto-enrollment in the 401k and other interventions for existing employees.[vi]
I always appreciate your criticisms, suggestions, corrections, improvements, etc. Please contact me at: jacktowarnicky@gmail.com
Disclaimer No. 1: My comments are my own based on my experience in plan sponsor and consulting roles – they do not necessarily reflect those of any employer, group, or association I have been employed by or affiliated with, past, present, or future.
Disclaimer No. 2: This information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have legal implications and you should discuss this matter with legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not (and you/others should not use it as a substitute for) legal, accounting, actuarial, or other professional advice. Any advice contained in this article was not intended or written to be used and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market, or recommend any transaction or subject addressed herein]. You (others) should seek advice based on your (their) particular circumstances from an independent tax advisor.
[i] American Payroll Association, Getting Paid in America, September 2021. Consistent with survey results for prior years, 63.4% of survey respondents confirmed that they would have some or significant difficulty meeting their financial commitments if their next paycheck were delayed (not missed) one week. Accessed 6/15/22 at: https://www.nationalpayrollweek.com/wp-content/uploads/2021/09/2021_Getting_Paid_In_America_survey_results.pdf [ii] Board of Governors of the Federal Reserve System, Economic Well-Being of U.S. Households (SHED), May 2022. “In 2021, nearly 60 percent of people said they had set aside money specifically as emergency savings or “rainy day” funds.” Accessed 6/15/22 at: https://www.federalreserve.gov/publications/2022-economic-well-being-of-us-households-in-2021-executive-summary.htm [iii] Vanguard, How America Saves, 2022. Workers who lack emergency savings are likely to be lower paid, with shorter service and younger. Participation is < 50% for the likely “target” population in plans with voluntary enrollment – those with annual incomes of less than $50,000, those with less than 3 years service, and those under age 35. My practical experience is that younger workers with lower incomes and short service disproportionately opt out in plans with automatic enrollment features and, fail to contribute enough to qualify for the full amount of employer financial support. Vanguard reports: “… within the entire employee universe, about 1 in 5 employees failed to take advantage of their employer’s plan….” “…In 2021, two-thirds of participants received the full employer matching contribution.” Accessed 6/15/22 at: https://institutional.vanguard.com/content/dam/inst/vanguard-has/insights-pdfs/22_TL_HAS_FullReport_2022.pdf [iv] J. Towarnicky, Adding a Sidecar Savings Account for Emergency Savings? Better Solutions May Exist, Benefits Quarterly, 1st Quarter 2022, See also: J. Towarnicky, Debt or Deferrals … College or Contributions? A 401kCan Do Double-Duty, Benefits Quarterly, 3rd Quarter 2019, See also: J. Towarnicky, Qualified Plan Loans: Evil or Essential? Benefits Quarterly, 2nd Quarter 2017, See also: J. Towarnicky, Top 10 401k Plan Loan Myths, Misdirections and Misrepresentations, 401kSpecialist.com, 2/17/21, Accessed 6/15/22 at: https://401kspecialistmag.com/top-10-401k-plan-loan-myths-misdirections-and-misrepresentations/ [v] W. De La Rosa, S. Tully, The Impact of Payment Frequency on Consumer Spending and Subjective Wealth Perceptions, Journal of Consumer Research, Volume 48, Issue 6, April 2022, Pages 991 – 1009, Accessed 6/15/22 at: https://academic.oup.com/jcr/article/48/6/991/6373900?login=false [vi] J. Towarnicky, It’s My Money and I Need it Now! 11/3/19, Accessed 6/15/22 at: https://www.psca.org/news/blog/it%E2%80%99s-my-money-and-i-need-it-now
Jack Towarnicky provides independent benefits consulting and serves as a member of aequum, LLC and of counsel for Koehler Fitzgerald, LLC.
