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

MarketWatch logo MarketWatch 10/10/2018 Richard Eisenberg
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While economists disagree over whether there’s a retirement-savings crisis in the U.S., one thing is clear: There’s an emergency-savings crisis.

Getting more Americans to save for emergencies, especially low- and middle-income earners, is crucial for their financial security. Not doing 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 whose results were published in August. And Prudential Financial says 69% of Americans have less than $1,000 in a savings account. A 2018 PwC Employee Financial Wellness Survey showed that “not having enough emergency savings for unexpected expenses” is the No. 1 financial concern of millennials and Gen Xers; for baby boomers, it’s No. 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 steps to correct the long-standing problem. The goal is creating a new type of emergency-savings plan for workers that is offered through employers.

“Interest has expanded almost exponentially,” said David John, a senior strategic policy adviser at the Washington, D.C.-based AARP Public Policy Institute who is part of the Brookings Institution Retirement Security Project. “Financial stress affects employees’ focus and productivity. One of the easiest ways to get the best out of your workforce is to help them have some peace of mind.”

U.S. workers are frequently tapping their 401(k) retirement plans through loans and hardship withdrawals to come up with cash for emergencies, putting in jeopardy retirement. Or they’re getting costly payday loans.

Twenty-nine percent of workers have taken a loan and/or an early withdrawal from a 401(k) or similar plan, or an individual retirement account, according to a recent Transamerica Center for Retirement Studies report. And, according to Newark, N.J.-based Prudential, 12 million Americans take out payday loans annually, incurring $9 billion in fees.

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

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

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“They find the basic concept very attractive,” said AARP’s John. “When you add some sort of incentive, it becomes a super feature that makes people even more likely to participate.”

Testing alternatives

But exactly how employers can offer rainy-day savings is murky and presents a number of obstacles — legal, administrative and behavioral. Nevertheless, a few pioneering employers and financial-services firms are testing out alternatives.

“Employers are still trying to sort out ways to do it, figuring out what are the pluses and minuses, the legal issues and the costs,” said Brigitte Madrian, the Aetna professor of public policy and corporate management at the John F. Kennedy School of Government at Harvard University in Cambridge, Mass.

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

Sidecar accounts

Prudential Financial and Prosperity Now, a research and public-policy nonprofit, teamed up recently to help employers set up sidecar accounts, alongside the firms’ 401(k) retirement-savings plans. One of Prudential’s clients, Kaneka North America (a subsidiary of a Japanese producer of chemical products and food supplements), began offering an account in September.

“Americans are not as resilient as they would like to be,” said Phil Waldeck, president of Prudential Retirement. “Almost two-thirds are not able to weather a $500 emergency. That is not only stressful and challenging for them in the short term but could send them off track for their long-term goals and retirement.”

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

In a sidecar account, an employee uses after-tax money (as opposed to the pretax money allocated to a retirement plan). Once the cash builds up to a predetermined level, future payroll deductions go into the retirement account. If the emergency-savings account drops below its intended target, money from the employee’s retirement fund is transferred in.

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

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Sidecars are funded with after-tax money because the Employee Retirement Income Security Act of 1974 law, known as ERISA, doesn’t specifically allow pretax saving through employers; investment earnings are taxed when withdrawn. Current law doesn’t allow auto-enrollment for sidecar accounts, either.

“Companies are understandably risk-averse when it comes to complying with ERISA,” said David Mitchell, associate director for policy and market solutions with the Aspen Institute Financial Security Program in Washington, D.C.

A bipartisan Senate bill, the Strengthening Financial Security Through Short-Term Savings Accounts Act of 2018, aims to rectify those drawbacks, letting employers automatically enroll workers in easily accessible stand-alone accounts or sidecar accounts. The bill would also see the Treasury Department create a pilot program that offers incentives to employers to set up short-term savings accounts. Companies could put $400 into each employee’s account.

The legislation appears unlikely to pass in 2018 because 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.

“My sense is the Trump administration is open to this type of approach,” said Shai Akabas, director of economic policy at the Washington, D.C.–based Bipartisan Policy Center, who favors the legislation. “It’s 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 is not setting up these accounts.”

DIY plans

Another experiment for emergency saving through employers takes more of a DIY approach. The employee opens an account at a bank or credit union, and the employer typically matches some or all of the contributions. Small employers are likelier to offer this type of emergency-savings program because of its lower cost and administrative burden, but some large companies are offering it, too.

SunTrust Banks in Atlanta and SafetyNet, a division of the Madison, Wis.–based CUNA Mutual Group, are trying out versions.

SunTrust has signed up 124 companies, including Delta Air Lines and Home Depot. Employees can ask their companies to auto-deposit a portion of their pay into their checking accounts, or they can arrange with their financial institution to routinely transfer a certain amount from their checking account to an emergency-savings account.

“We encourage employers to offer a match,” said Brian Nelson Ford, a financial-well-being executive at SunTrust. “We want them to have skin in the game.”

SunTrust gives its employees $1,000 apiece if they make automatic contributions to emergency savings; 23,000 employees have signed up, and SunTrust has paid out $13 million.

‘Cookie Jar’

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

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

“At the end of the month, the employer matches the savings, giving employees the incentive to keep the money in savings and to continue to save more,” said Roshni Chowdhry, head of customer experience at SafetyNet. Matches range from 10% to 100% of employee contributions, up to a preset limit.

Employees can also arrange to put another $20 into the Cookie Jar as often as they wish.

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

Richard Eisenberg is managing editor of Next Avenue and the author of “How to Avoid a Mid-Life Financial Crisis.”

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