Is Congress Mad? Are You Feeling the Same?

There’s a whole lotta leakage^[i] going on.^[ii] Before passage of SECURE 2.0, I lamented all the opportunities where Congress had previously added retirement plan liquidity that encouraged leakage and criticized Congress’ unwillingness to leverage and enhance other liquidity options that can be structured to minimize leakage.^[iii]

These increases occurred before SECURE 2.0 added new leakage options.

Unmoored: /ˌənˈmo͝ord/ adjective Meaning: … (of a person or here, Congress) insecure, confused, or lacking contact with reality.^[iv]

This article highlights most of the “leaks” added by SECURE 2.0.

Please read to the end and learn how to increase liquidity AND reduce leakage.

SECURE 2.0: More Leakage, Less Deferrals and Fewer Repayments

SECURE 2.0 adds the following new leaks:

Sec. 113. Small, immediate, taxable financial incentives for contributing to a plan (in lieu of a larger match or non-elective contribution).
Sec. 115. Withdrawals for certain emergency expenses (up to $1,000, once a year).
Sec. 304. Updating dollar limit for mandatory distributions.
Sec. 312. Plan Administrator reliance on participant certification of hardship conditions.
Sec. 314. Penalty-free withdrawals due to domestic abuse (lesser of 50% of vested account balance/accrued benefit or $10,000).
Sec. 326. Penalty-free withdrawals for those certified to be terminally ill (within the next seven years).
Sec. 329. Penalty-free withdrawals for public safety officers – the earlier of age 50 or completing 25 years of service.
Sec. 330. Penalty-free withdrawals for state/local government corrections employees at age 50.
Sec. 331. Makes indefinite (nothing is permanent when it comes to the tax code) qualified federal disaster rules—withdraw up to $22,000 per disaster, 3-year income averaging, increase the maximum loan amount, and extend repayment periods.
Sec. 334. Penalty-free withdrawals to purchase long-term care (LTC) insurance, limited to the least of (1) LTC premium, (2) 10% of vested accrued benefits or (3) $2,500/year (indexed).
Sec. 602. Update 403(b) hardship withdrawal rules to conform with more liberal 401k rules.

It is never enough. So, SECURE 2.0 adds features that may dampen deferrals and repayments:

Sec. 110. Student loan payments treated as elective deferrals for matching contributions.
Sec. 127. Emergency savings accounts linked to individual account retirement savings plans.
Sec. 311. Repayment period for qualified birth or adoption withdrawals now limited to three years.
Sec. 314. 3-year repayment limit applies to penalty-free withdrawals in cases of domestic abuse.
Sec. 320. Reduced disclosure requirements for the “unenrolled.”

Some believe these and other items combine to change the momentum in retirement savings. I have heard it described as a “game changer.” Perhaps it is—but not in a favorable way. It certainly reminds me of football or basketball games disrupted by multiple turnovers.

Let’s look at one of these “game changers” in more detail: emergency savings accounts.

Here, the goals are to increase savings AND reduce leakage. Supposedly, saving in two dedicated subaccounts in the same plan will reduce the number of withdrawals sourced from the account where we hang a sign on it that says “retirement.”^[v] This is a variant of the “envelope” budgeting system but limited to two envelopes.^[vi]

It just isn’t so. Here is why.

Most workers who lack emergency savings are most likely the same workers who live paycheck to paycheck. Also, they are likely to be in debt.^[vii] Diverting attention from a tax-favored, employer-matched retirement savings plan that incorporates “liquidity without leakage” is suboptimal for many reasons—including, but not limited to:

SECURE 2.0 only allows sidecars if there is a tax-qualified plan.
Most workers don’t optimize savings—the median annual 401(k) contribution is < $2,200 (~20% do not contribute).^[viii] Why add options most won’t use?
Today, one-third don’t contribute enough to receive the maximum match. Why add options that would discourage deferrals, a form of “crowd-out.” And, crowd-out is much more likely if you add an “auto” sidecar.^[ix]
Most 401(k)s have < 100 participants, and < 50% of those plans use “auto” features. Few of these plans will add “auto” features, fewer will also add sidecars, and only a handful will add “auto” sidecars.^[x]
A Roth IRA is clearly superior once a worker has contributed enough to receive the full employer financial support in both the 401(k) and the Health Savings Account (HSA). Like the 401(k), saving in a Roth IRA can be automatic—via a Deemed Roth IRA. No need to limit the emergency savings to taxable capital preservation investments. Importantly, some IRAs have no admin and ultra-low or no asset management fees.
Finally, to be effective, a sidecar must be replenished.

The Best Option to Increase Savings, Facilitate “Replenishment” AND … Reduce Leakage

“If financial fragility is the illness to be cured, and if leakage from your participants’ retirement savings accounts (401(k), 403(b), etc.) is one of the symptoms, a sidecar emergency savings account may be more likely to add a comorbidity than to provide a cure. Yes, every individual needs to prepare for financial emergencies. However, sidecar savings does not qualify under a standard set by the General Accountability Office (GAO) as ‘the most appropriate and least damaging option.’ Your workers already have within their hands the only tool they need—their retirement savings plan “done right”—to achieve financial wellness and to fashion their financial destiny. Keep it simple, focused. Leverage the commitment you’ve already made. Start by challenging your service provider to update plan loan processing to 21st century functionality.”^[xi]

Workers Do Need Liquidity, But Liquidity “Done Right”

Is Congress Mad? Mad /mad/ adjective BRITISH: Mentally ill; insane.

Are you? Mad /mad/ adjective: Very angry.

The best part about the SECURE 2.0 liquidity changes is that almost all are voluntary.

You and other plan sponsors need not add those features to your plan.

My team implemented a superior liquidity solution in my last plan sponsor role. Over a period of 13 years, we added plan loans, eliminated hardship withdrawals, and then updated loan processing to 21st Century functionality—so the plan offered “liquidity without leakage along the way to and throughout retirement” to all participants, including term vested and retirees.^[xii] 21st Century plan loan processing can include, but is not limited to: electronic banking, a line-of-credit structure and behavioral economics tools, concepts and processes—one example, having participants execute loan applications as both the borrower and the lender (future self).

That plan design is a superior alternative, compared to adding a sidecar, if your goal is more savings, better/greater liquidity, a “default” that will automatically “replenish” with LESS not MORE leakage.

Any better ideas? Happy to review, discuss, and debate. Always appreciate your insights and criticisms. Contact me at: jacktowarnicky@gmail.com

Disclaimer No. 1: My comments are my own based on my past experiences in plan sponsor roles and do not necessarily reflect those of any employer or association I have been employed by or affiliated with, past, present, or future.

Disclaimer No. 2: 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 may not be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may otherwise 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] Let’s define some terms. To quote Humpty Dumpty, when I define terms: “When I use a word… it means just what I choose it to mean – neither more nor less.” Liquidity: Any withdrawal, distribution or loan from an employer-sponsored, tax-qualified plan or IRA, whether monies are accessed while employed, as a term vested participant or a “retiree”. Retiree: A worker who has commenced payout of retirement assets after ending all employment at/after age 55 and after 25 or more years of employment. Leakage: Any loan that is not repaid, and almost all withdrawals and distributions prior to retirement.

^[ii] A. Tergesen, Short on Cash, More Americans Tap 401(k) Savings for Emergencies. A rise in hardship withdrawals from retirement accounts is driven by financial strain and looser regulations, plan providers say. 2/2/23, Accessed 2/3/23 at: https://www.wsj.com/articles/short-on-cash-more-americans-tap-401-k-savings-for-emergencies-11675305976?page=1

^[iii] J. Towarnicky, Congress: Did You Ever Have to Make Up Your Mind? Are the tax preferences for assets in retirement savings plans intended for retirement? If so, you may want to stop proposing legislation that enables and encourages leakage, 9/21/22, Accessed 2/2/23 at: https://401kspecialistmag.com/congress-did-you-ever-have-to-make-up-your-mind/

^[iv] Wikipedia, Capsizing, Accessed 2/2/23 at: https://en.wikipedia.org/wiki/Capsizing

^[v] J. Beshears, J. Choi, J. Mark Iwry, D. John, D. Laibson, B. Madrian, Building Emergency Savings Through Employer-Sponsored Rainy-Day Savings Accounts, 11/11/19, Accessed 2/2/23 at: www.nber.org/papers/w26498

^[vi] CapitalOne, How to Use the Envelope Budget System, Money Management, 12/22/22, Accessed 1/5/23 at: https://www.capitalone.com/learn-grow/money-management/envelope-budget-system/

^[vii] American Payroll Association (APA), Getting Paid In America Annual Survey, 2022. 71.4% of survey respondents (20,079 out of 27,833) indicated it would be somewhat or very difficult to meet their current financial obligations if the next paycheck was delayed a week (that’s delayed, not missed, and delayed just one week). Accessed 2/2/23 at: https://info.americanpayroll.org/pdfs/npw/2022_Getting_Paid_In_America_survey_results.pdf See also: Federal Reserve Bank of New York, Quarterly Report on Household Debt and Credit, 3^rd Quarter 2022. “Total household debt rose by $351 Billion (2.2%), to $16.51 Trillion in the 3^rd quarter of 2022” – a new, all-time high. Accessed 2/2/23 at: https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2022Q3

^[viii] Author’s estimates based on data from Department of Labor (DOL), Form 5500 Historical Tables (1975 – 2020), Accessed 2/2/23 at: https://www.dol.gov/sites/dolgov/files/ebsa/researchers/statistics/retirement-bulletins/private-pension-plan-bulletin-historical-tables-and-graphs.pdf See also: Vanguard, How America Saves, 2022. The median deferral rate of 6.1% times the median salary of $35,346 = $2,156 – ignoring the ~20% of eligibles who do not contribute. Accessed 2/2/23 at: https://institutional.vanguard.com/content/dam/inst/vanguard-has/insights-pdfs/22_TL_HAS_FullReport_2022.pdf

^[ix] Vanguard, note viii, supra.

^[x] DOL, Note viii. supra.

^[xi] J. Towarnicky, Adding a Sidecar Savings Account for Emergency Savings? Better Solutions May Exist, Benefits Quarterly, 1^stQuarter, 2022, citing: 1. R. Clark, A. Lusardi, O. Mitchell, “Financial Fragility During the COVID-19 Pandemic,” NBER, December 2020. Accessed 2/2/23 at: www.nber.org/system/files/working_papers/w28207/w28207.pdf. And Joint Committee on Taxation (JCT), “Estimating Leakage From Retirement Savings Accounts,” JCX-20-21, 4/26/21, Accessed 1/6/23 at: www.jct.gov/publications/2021/jcx-20-21/ . See also: Savings Preservation Working Group, Cashing Out: The Systemic Impact of Withdrawing Savings Before Retirement, 10/29/19, Accessed 2/2/23 at: https://tsretirement.com/wp-content/uploads/2020/02/cashing-out-issue.pdf See also: U.S. Government Accountability Office (GAO), Policy Changes Could Reduce the Long-term Effects of Leakage on Workers’ Retirement Savings, GAO 09-715, August 2009. Accessed 1/6/23 at: www.gao.gov/products/gao-09-715.

^[xii] J. Towarnicky, note iii, supra. See also: Top 10 401k Plan Loan Myths, Misdirections and Misrepresentations. 401kSpecialist.com, 2/17/21, Accessed 2/2/23 at: https://401kspecialistmag.com/top-10-401k-plan-loan-myths-misdirections-and-misrepresentations/ See also: J. Towarnicky, Qualified Plan Loans: Evil or Essential, Benefits Quarterly, Second Quarter, 2017.