‘Rainy Day’ Savings Accounts Prevent 401(k) Raids but Face Regulatory Hurdles

Employer-sponsored emergency accounts and low-interest loans can protect retirement funds

Stephen Miller, CEBS By Stephen Miller, CEBS November 1, 2017
updated on Nov. 8, 2017

Many Americans live paycheck to paycheck, carry credit card debt, and have little or no money set aside for common emergencies such as car or home repairs. Employer-sponsored "rainy day" savings funds can help them put aside dollars so they don't have to take out high-interest loans or raid their 401(k) accounts when emergencies happen, said speakers at an Oct. 26 forum held at the Brookings Institution in Washington, D.C.

Unfortunately, current laws and regulations make it difficult for employers to use a joint administrator for both retirement plans and emergency savings accounts, and to provide the kinds of automatic features for savings accounts that have helped employees to build up their 401(k) retirement savings.

"For every $2 that flows into the U.S. retirement savings system, almost $1 leaks out" before retirement, said Brigitte C. Madrian, Aetna professor of public policy and corporate management at the Harvard Kennedy School. "Industry data suggests that at any point in time about 1 in 5 participants has an outstanding loan" against their retirement plan savings, she noted.

Employees are tapping into their 401(k) account balances "because for many people, it's all they have," she explained.

When the National Financial Capability Study asked people how confident they were that they could come up with $2,000 if an unexpected need arose within the next month, "a full 40 percent said that they probably couldn't come up with that amount. And $2,000 is the cost of a lot of things that happen with some regularity," said Madrian.

Even more concerning, last year a Federal Reserve study found that 46 percent of adults would need to charge a $400 unexpected expense, due to a lack of savings.

(Click on chart below to view in a separate window.)

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Source: The Society for Human Resource Management's 2017 Employee Benefits survey, which polled SHRM members in January and February 2017.

Madrian and fellow researchers have proposed that employers promote emergency savings so as "to leave [the use of] retirement savings off-limits for reasons other than retirement," she said.

Due to "mental accounting," Madrian explained, employees are less likely to withdraw more than they might actually need out of a larger retirement fund if, instead, they have access to a smaller fund that's designated for emergencies.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Not Just for Low-Earners

Studies show that "the lack of cash availability actually runs up and down the income scale," said David C. John, deputy director of The Brookings Institution's Retirement Security Project. "So we cannot make the assumption that just because a family is earning $200,000 or more that they have three months' worth of savings, or even $2,000 worth of savings."

As a result, "it's not just lower-wage earners who are raiding their 401(k)s," he noted.

Integrating 401(k) and Emergency Accounts

Combining the administration of an emergency savings account with an existing 401(k) plan could provide administrative efficiencies, such as making it easier to use automatic enrollment for the emergency account and for employers to match employees' contributions, John said. In addition, integrated administration could "allow contributions to be adjusted automatically across the two accounts to maintain a minimum account balance in the rainy day fund, with all contributions allocated to the retirement account once a target balance in the rainy day fund is met," he explained.

"Ideally, we would be in a position where we could just implement this without any trouble. Unfortunately, both legal and regulatory regimes for retirement and nonretirement savings are slightly different," he noted.

For instance, treating the emergency fund as an after-tax 401(k) subaccount would bring into play compliance and reporting requirements under the Employee Retirement Income Security Act (ERISA), John noted. As a result, withdrawn earnings would be subject to taxes and penalties, and the timeliness of withdrawals would be impeded.

"If your tire blows out at 9:00 a.m., the 401(k) system is not designed to provide you with money by 5:00 p.m.," he said.

Setting Up Separate Bank Accounts

Alternatively, setting up an emergency fund as a separate bank or credit union savings account—or even through a payroll card—has its own advantages and disadvantages, John noted. While it would keep the emergency fund exempt from ERISA, for instance, on the downside:

  • Auto-enrollment may not be possible without reform.
  • Bank fees may be an issue.
  • An employer match would be taxable.
  • Coordinating contributions with a 401(k) plan would be difficult.
  • Bank accounts don't have access to 401(k) stable value funds, which pay higher interest on savings than bank money market funds.

Promoting Financial Well-Being

Diane Garnick, chief income strategist at TIAA, which provides retirement plan financial services, pointed out that "in the long run, we're not just hoping that people have enough money for an emergency. Our goal is to make sure that people acquire better budgeting skills," which requires that employers provide financial wellness tools and education.

On a lighter note, Garnick added, "Honestly, I don't like that we came up with the name of 'rainy day' fund because if I close my eyes and think of rainy days, I imagine playing board games. How about if we named it something dramatic like the 'don't bust your budget' account?"

Providing Access to Low-Interest Personal Loans

"More U.S. employers are teaming up with financial institutions such as credit unions to offer small personal loans to their workers, offering employees a way to bridge financial crunches without turning to high-cost payday loans," the Wall Street Journal recently reported.

For example:

Rhino Foods Inc., a Burlington, Vt., company that makes ice-cream ingredients, teamed up with a local credit union to provide same-day loans of as much as $1,000 with no credit checks and no questions asked to any employee that has worked at the company for at least a year. The loans' current annual interest rate is 16.99 percent, a fraction of the rates for payday credit—small consumer loans used by millions of Americans each year—which can climb to 400 percent.

Credit unions keep underwriting costs low by having employers vouch for an employee's ability to repay the loan. Automated payroll deductions keep repayment rates high.

"While the companies' HR departments process payroll deductions, loans are kept confidential from the borrowers' managers and company officials," Yuka Hayashi reported. In addition, "Some programs also encourage employees to build rainy-day funds by continuing payroll deductions even after the loans are paid off."

Low-Interest vs. High-Interest Loans

According to SHRM's 2017 Employee Benefits survey, 15 percent of SHRM members said their organizations offer loans to employees for emergency/disaster assistance, while 7 percent provide low- or no-interest loans to employees for nonemergency situations.

A poll of 1,000 adult Americans who took out a high-interest payday loan last year found that the average loan amount was $442.16. Payday loan users took out, on average, four such loans last year, while just over 31 percent of these borrowers used one payday loan to pay off another, according to the survey by student loan firm LendEDU.

Related SHRM Articles:

Take a Team Approach to Financial Wellness, SHRM Online Benefits, October 2017

Tying Health Plan Premiums to Salary Can Aid Lower-Paid Earners, SHRM Online Benefits, October 2017

Employers Sharply Increased Financial Well-Being Benefits in 2017, SHRM Online Benefits, June 2017

Reach Out to Workers Living Paycheck-to-Paycheck, SHRM Online Compensation, September 2016

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