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Is it Time to Pair an Emergency Savings Fund with a 401(k) Plan?

Industry Trends and Research

Given the high percentage of workers who say they could not cover an emergency expense, a new report examines the case for an employer-based emergency savings option – possibly in combination with a DC plan – to help prevent workers from raiding their DC plans when emergencies strike. 

In “Emergency Savings: The Reality of Workers’ Liquid Savings – Evidence from the Survey of Consumer Finances,” the Employee Benefit Research Institute (EBRI) examines data from the Federal Reserve on the likelihood of workers and families having sufficient emergency savings to cover three months of expenses, as well as the potential impact of DC plan eligibility when it comes to having sufficient emergency savings. 

According to EBRI’s research, half of American workers report having a rainy-day fund that could cover three months of expenses, but only one in five families have liquid savings of more than three months of their family income. 

EBRI explains that one consideration families with limited savings capabilities face is whether to fund an emergency account or save for retirement through a DC plan. The issue brief notes that those with access to a DC plan with a matching contribution may reason that it is more attractive to save in it, especially since loans and withdrawals make the DC money accessible and the money can also be withdrawn upon a job change. On the other hand, if an emergency happens – particularly a job loss – removing funds from a DC plan can result in early withdrawal tax penalties, which is not an attractive option.

Craig Copeland, Senior Research Associate at EBRI and author of the issue brief, observes that, “Given the low percentage of workers and families who have sufficient savings to cover a loss of income for any extended period, emergency savings programs could be directly beneficial to workers and indirectly beneficial to employers through higher employee satisfaction.”  

DC Plan Participants

As it turns out, families whose heads were DC plan participants were found to be more likely to have sufficient liquid savings to cover three months of expenses. Notably, families whose heads are eligible to participate in a DC plan but don’t were the least likely to have adequate savings for an emergency. 

According to EBRI’s findings, nearly 25% of families with working heads who were DC plan participants had more than three months of income in liquid savings, but only 13% of eligible nonparticipants did. Surprisingly, that level is even lower than the nearly 18% of families with working heads who were not offered a DC plan, the paper notes. 

What’s more, EBRI found that this lack of liquid savings is not limited to just families with low incomes or younger heads – it spans both age and income spectrums. “Despite some employees preparing for retirement through participation in a DC plan, help apparently is needed by a sizable share of these employees for short-term financial issues,” Copeland suggests, further noting that the potential need is even more pressing for those who are eligible for the plan but do not participate. 

EBRI notes that addressing short-term financial issues could lead to even better long-term results through a reduced need for early withdrawals (and tax penalties) and potentially higher contributions to a DC plan after an account for short-term financial issues is funded.

But while employers that already offer a DC plan are likely to have the infrastructure to provide such a benefit, EBRI acknowledges that implementation of such plans would be difficult given the current rules surrounding DC plans. Copeland suggests that creative ideas are needed as well as willingness of employers to offer this type of benefit. 

As for whether there would be any demand for a rainy-day savings program among workers, a 2018 nationwide survey commissioned by AARP and designed by Boston Research Technologies revealed that more than 7 out of 10 employees (71%) would likely participate in a payroll-deduction rainy-day savings program if their employer offered one. 

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