Argument for Auto-Enroll Emergency Savings

PLANSPONSOR was recently invited to attend the taping of a live retirement industry trends webcast hosted by J.P. Morgan Asset Management, and to speak afterwards with the various presenters, including Ida Rademacher of The Aspen Institute Financial Security Program.

Rademacher’s commentary during the presentation drew heavily on lessons learned from the April 2017 inaugural Aspen Leadership Forum on Retirement Savings, held in Middleburg, Virginia. The forum brought together roughly 60 senior leaders from industry, government, academia and the lobbying community to discuss “breakthrough solutions to one of the most critical financial challenges facing American households—the lack of adequate savings for retirement.”

David Mitchell, senior program manager at the Financial Security Program (FSP) at the Aspen Institute, penned a helpful summary of the event, also drawing on his experience as a legislative aide to U.S. Senator Sherrod Brown (D-Ohio) focused on health care reform and Social Security. According to Mitchell and Rademacher, many forum attendees felt a crucial but overlooked challenge impacting the retirement savings efforts of many U.S. workers is the widespread occurrence of unanticipated financial shocks—ranging from pay cuts, trips to the hospital emergency room, spousal separation, major car or home repairs, or other large non-recurring expenses.

Rademacher cited data from Pew Charitable Trusts noting that 60% of American families experienced one of these events in just the past 12 months. At the same time, data from Prosperity Now shows 44% of households did not put any money towards emergency savings in the past year.

“It is not surprising that many families are forced to tap long-term assets, especially retirement accounts, to deal with income volatility and other short-term financial hardships,” Rademacher observed. “The data shows one in four people with a DC plan will use all or some of  their savings for non-retirement purposes, whether that is for paying a bill, buying a home, dealing with a medical emergency, or sending a child to an expensive college.”

Rademacher and Mitchell suggest one way to help families cope is to link a short-term emergency savings, or sidecar account, to a traditional retirement account. The pair argues such an approach helps savers to think about their financial picture holistically—and to understand the importance of protecting tax-advantaged investments as time goes by. Of course, the linking of the retirement savings account and the emergency savings account must be substantial and designed with choice architecture in mind, but it can be very powerful, the pair feels.  

Mitchel explains the mechanics: “The idea is relatively simple. Workers who do not yet have emergency savings will be directed to first fund a short-term savings account reserved for emergencies. Once a sufficient savings buffer has been built up, additional contributions are automatically diverted to a traditional, less-liquid retirement account.”

To promote a constant savings buffer, the short-term account will again be automatically prioritized in the event the original buffer is spent down.

“The hope is that by formalizing the dual role the retirement system currently plays, savers would be in a better position to distinguish between and maximize what is available now and what is locked away for retirement,” Mitchell says.

The pair are relatively agnostic about the specific details of the sidecar accounts. As Rademacher lays out, key questions to answer here include determining which institutions should provide what service; how the accounts should be structured for fiduciary liability and tax purposes; at what deferral level participants should be automatically enrolled; exactly how large of a balance should accumulate in the buffer account before the shift to retirement savings; and finally, what withdrawal restrictions should be placed on the two accounts.

Important to note, the experts highlighted that there was some skepticism about this innovation expressed at the Aspen forum. In particular, experts warned sponsors may feel concerned about the lack of clear legal authority for employers to automatically enroll workers in such a sidecar savings account. Even more to the point, experts suggested there is an unknown level of consumer and plan sponsor demand for such an innovation.

“Indeed, some forum attendees worried that creating yet another type of savings account could complicate the already difficult-to-navigate savings choice architecture,” Mitchell warns. “Nevertheless, several forum participants said they plan to experiment with the idea in coming years.”