I met Katherine a few years ago as she was preparing to deliver a talk about emergency savings at a special International Foundation event. She was very low-key and approachable, and she had a bad cold. I was nervous for her, having to speak in front of a big daunting crowd, with her red nose and a small mountain of Kleenex. Then she got up onto that stage and blew everyone away—without sneezing.
Katherine told us a story that displayed bravery: She revealed an uncomfortable truth and, with tremendous persistence, persuaded a long line of executives to do something about it.
The uncomfortable truth: Employees at her work, a financial services institution, did not have emergency savings. These are employees, from frontline tellers to senior-level financial strategists, who were not in a position to adequately finance a new set of tires. This reminds me of my OB/GYN who, at 40-something, found herself totally, unexpectedly pregnant, but that’s a different story.
Back to Katherine. What she discovered is that many of her colleagues were living paycheck to paycheck with little in their back pockets to handle life’s emergencies. What was shocking to me was that this was a group of people I would assume had their finances squared away.
When it comes to having a little cushion in the savings account, I’ve learned that I’m not that unusual. When the water heater gives out or that fender bender happens, many people don’t have the cash on hand and turn to emergency loan shops, which charge exorbitant interest. A recent Federal Reserve Survey found that 44% struggle to come up with $400 for an unexpected expense. This lack of a well-funded emergency fund happens throughout the income scale.
There are a number of different theories as to why we don’t have this cushion, such as present bias, which means we overweigh the present situation more so than the future. Another psychological phenomenon that prevents us from forecasting future income needs that when we have inflows of money (a raise, for example), we tend to focus on a new thing to buy with that extra money, and we don’t think about other rising expenses. Any extra money in our pockets goes to instant gratification. Are we undisciplined? Maybe, but more science is pointing to the fact that we are humans making consistently irrational decisions.
So What Can an Employer Do?
Defined contribution (DC) plans can offer hardship loans from their DC plans. This, of course, should not be the first stop when you need a new set of tires. More innovative approaches include combining the administration of an emergency savings account with an existing 401(k) plan. This way the tools you might already have, like autoenrollment or an employer match, are already in place. But with that convenient structure also comes ERISA compliance issues and withdrawal penalties. Also, emergencies require quick access to cash, and these types of plans might not be able to deliver in a timely manner.
Related—401(k) Plan Administration online course.
According to the International Foundation Employee Benefits Survey 2016, few employers are currently offering loans as a benefit. Only 1.0% of surveyed organizations offer no- or low-interest loans, and .3% offer a general purpose loan as part of their survivor benefit offering.
Collaborating with a financial institution to offer small personal loans is an effort to circumvent a high-interest loan or raiding of retirement savings, according to the Wall Street Journal. While this option may pose fewer compliance risks for the employer, the downsides include
- An inability to autoenroll employees
- Any match provided would be taxable
- Coordinating contributions with a DC plan would be cumbersome.
This is new territory and the regulations aren’t clear. Would there be fees? How would coordination with an existing DC plan work? What if the employees want to use their own bank rather than one the employer chooses? And what happens if the employee is terminated?
I’ll Have a Sidecar
One way to avoid taxation issues with emergency savings accounts is to establish a deemed Roth IRA account, which would be funded by after-tax contributions. Called a sidecar, money is deferred into an account until a certain amount is reached, called the buffer. Once that point occurs, the deferrals can switch into the retirement plan. Since this is still a relatively untested approach, there are a few hurdles to cross. How would the earnings and withdrawals be taxed? Would a withdrawal be considered an early distribution and penalized as such? How is the buffer amount determined? How would matches work? And don’t get me started on partitioning.
Despite these hurdles, more firms are getting into the game of helping create a resource for employees to go to for emergency funds. A few retirement providers have introduced this as a product offering, and at least one credit union has created a savings account product for employers. SunTrust built a successful emergency savings program for their employees and they went on to figure out how to share their experience with their customers.
While the waters are untested, it may be well worth a look into this benefit for employees. It’s a relatively inexpensive, highly valued benefit that can give employees peace of mind and avoid those “whoa” moments.
Stacy Van Alstyne
Communications Director at the International Foundation