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The sidecar plan that could soon be attached to your 401 (k)

While economists disagree on the existence of a retirement savings crisis in the United States, one thing is clear: there is an emergency savings crisis.

Getting more Americans to save for emergencies, especially low- and middle-income people, is crucial to their financial security. Failure to do so can result in financial ruin.

The statistics are scary. In the past year, 48% of households faced at least one unexpected expense related to an emergency, according to a CIT Bank survey, the results of which were released in August. And Prudential Financial says 69% of Americans have less than $ 1,000 in a savings account. A 2018 PwC Employee Financial Well-Being Survey found that “not having enough emergency savings for unexpected expenses” is the # 1 financial concern of Millennials and Gen Xers; for baby boomers, it’s # 2 after retirement worries.

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Help may be on the way. A growing number of employers, benefit plan sponsors, policy analysts and members of Congress are taking action to correct this long-standing problem. The goal is to create a new type of emergency savings plan for workers that is offered by employers.

“Interest has grown almost exponentially,” said David John, senior strategic policy advisor at the Washington, DC-based AARP Public Policy Institute, which is part of the Brookings Institution Retirement Security Project. “Financial stress affects the concentration and productivity of employees. One of the easiest ways to get the most out of your staff is to give them peace of mind. “

“So many people don’t have the capacity to face a financial emergency, so their 401 (k) is the only pot of money they can tap into.”

– Rachel Weker, T. Rowe Price

American workers frequently exploit their 401 (k) retirement plans through hardship loans and withdrawals to find cash in an emergency, putting their retirement in jeopardy. Or they get expensive payday loans.

Twenty-nine percent of workers have taken out a loan and / or early withdrawal from a 401 (k) or similar plan, or individual retirement account, according to a recent report from the Transamerica Center for Retirement Studies. And, according to Newark, New Jersey-based Prudential, 12 million Americans take out payday loans each year, resulting in costs of $ 9 billion.

“So many people don’t have the capacity to face a financial emergency, so their 401 (k) is the only pot of money they can tap into,” said Rachel Weker, TROW vice president of T Rowe Price Group,
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pension division in Baltimore.

Americans are embracing the idea of ​​sponsored workplace emergency savings plans, based on focus groups and a study conducted by AARP. In a survey of 2,603 ​​employees aged 25 to 64, three in four said they were attracted to an employer-sponsored emergency savings program, and almost all said they did. would participate if their employer matched their contributions.

“They find the basic concept very appealing,” said John of AARP. “When you add some kind of incentive it becomes a great feature that makes people even more likely to participate.”

Testing alternatives

But exactly how employers can offer savings for a rainy day is unclear and presents a number of hurdles – legal, administrative and behavioral. Nonetheless, a few pioneering employers and financial services companies are testing alternatives.

“Employers are always trying to find ways to do it, to figure out what the pros and cons, the legal issues and the costs are,” said Brigitte Madrian, Aetna professor of public policy and business management at John F. Kennedy School. government at Harvard University in Cambridge, Mass.

There are two main types of emergency savings plans offered by employers: so-called “sidecar” or “rainy day” accounts, which are supplements to retirement savings plans such as 401 (k). ; and the do-it-yourself arrangements that employees set up with grants from employers.

Supplementary accounts

PRU Financial Prudential,
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and Prosperity Now, a nonprofit research and public policy organization, recently teamed up to help employers create side accounts, alongside companies’ 401 (k) retirement savings plans. One of Prudential’s clients, Kaneka North America (a subsidiary of a Japanese producer of chemicals and dietary supplements), will begin offering an account in 2019.

“Americans are not as resilient as they would like,” said Phil Waldeck, president of Prudential Retirement. “Almost two-thirds are unable to overcome a $ 500 emergency. It’s not only stressful and difficult for them in the short term, but it could derail them from their long-term goals and retirement. “

Waldeck called sidecar accounts “the natural next step in the design of retirement and its impact on the workplace.” A survey conducted by the LIMRA Secure Retirement Institute found that two-thirds of workers are interested in sidecar accounts.

In a side account, an employee uses after-tax money (as opposed to pre-tax money allocated to a pension plan). Once the after-tax money reaches an employee’s comfort level, future payroll deductions can then be allocated to their pre-tax retirement savings. If the after-tax emergency savings balance falls below its intended target due to withdrawals, the employee can replenish the balance back to its target with future after-tax contributions.

“What Prudential is doing makes perfect sense for the large employer with a comprehensive retirement platform,” said John, of the AARP Public Policy Institute.

Sidecars are funded with after-tax money because the Employees Retirement Income Security Act of 1974, known as ERISA, does not specifically allow pre-tax savings by employers. for short-term savings; investment income is taxed upon withdrawal. The current law also does not explicitly allow automatic registration for sidecar accounts.

“Businesses are understandably risk-averse when it comes to complying with ERISA,” said David Mitchell, associate director of policy and market solutions in the financial security program at the Aspen Institute in Washington, DC

A bipartisan Senate bill, the Strengthening Financial Security through Short-Term Savings Accounts Act of 2018, aims to rectify these drawbacks, by allowing employers to automatically enroll workers in stand-alone accounts or easily accessible side accounts. The bill would also see the Treasury Department create a pilot program that offers incentives for employers to set up short-term savings accounts. Businesses could receive up to $ 400 per account as an incentive.

It seems unlikely that the legislation will be passed in 2018 as time is running out. The bill is sponsored by Democrats Heidi Heitkamp of North Dakota and Cory Booker of New Jersey and Republicans Tom Cotton of Arkansas and Todd Young of Indiana.

“I have a feeling the Trump administration is open to this type of approach,” said Shai Akabas, director of economic policy at the Washington, DC-based Bipartisan Policy Center, which is supportive of the legislation. “It is important to recognize a significant distinction between these accounts and myRAs [starter retirement-savings accounts created under the Obama administration and ended by Trump]. The government does not keep these accounts.

DIY plans

Another emergency savings experience through employers is more of a DIY approach. The employee opens an account with a bank or credit union, and the employer usually pays some or all of the contributions. Small employers are more likely to offer this type of emergency savings program due to its lower cost and administrative burden, but some larger companies offer it as well.

SunTrust Banks United States: STI
in Atlanta and SafetyNet, a division of Madison, Wisconsin-based CUNA Mutual, are testing versions.

SunTrust has signed 124 companies, including Delta Air Lines DAL,
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and Home Depot HD,
+ 1.16%.
Employees can ask their company to automatically deposit part of their salary into their checking account, or they can arrange with their financial institution to systematically transfer a certain amount from their checking account to an emergency savings account.

“We encourage employers to propose a match,” said Brian Nelson Ford, financial wellness manager at SunTrust. “We want them to have skin in the game.”

SunTrust gives its employees $ 1,000 each if they automatically contribute to Emergency Savings; 23,000 employees signed up and SunTrust contributed $ 13 million.

‘Cookie box’

SafetyNet calls its new program Cookie Jar. So far, it’s open to employers headquartered in Wisconsin and Iowa; some CUNA Mutual employees will soon be invited to register. Employers pay $ 3 per month per enrolled employee, plus matching contributions made.

With Cookie Jar, SafetyNet rounds employee purchases with debit cards to the nearest dollar, then deposits spare change in a “cookie jar” for them. Employees’ emergency savings accounts are therefore placed in an institution insured by the FDIC.

“At the end of the month, the employer equalizes the savings, prompting employees to keep the money in their savings and continue to save more,” said Roshni Chowdhry, Customer Experience Manager at SafetyNet. Matches range from 10% to 100% of employee contributions, up to a predefined limit.

Employees can also arrange to put an extra $ 20 in the cookie jar as often as they like.

The amounts may seem small, but, Chowdhry said, “An additional $ 200 or $ 300 accumulated by the end of the year is better than nothing, and it instills the practice of saving.”

Richard Eisenberg is editor-in-chief of Next avenue and the author of “How to Avoid a Mid-Life Financial Crisis. “

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