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5 Reasons Emergency Savings Within 401(k)s Are a Great Idea
Last Updated: March 26, 2024
Financial insecurity is not new. It’s been a problem for far too long, as we’ve highlighted in our recent blog post.
Seemingly every week we see more reports reinforcing that this is an enduring and widespread concern. Let’s face it, many Americans struggle to get ahead. This financial insecurity, characterized by living paycheck to paycheck, manifests itself in an ever-present cloud of stress and worry.
The problem is rooted in a lack of savings, which can be categorized into two distinct types: 1) a lack of emergency (i.e. short-term) savings, or the inability to withstand financial shocks, and 2) a lack of retirement (i.e. long-term) savings, or a sense of hopelessness for a secure financial future. To improve the financial security of the American workforce, we need to address both.
A new law seeks to do just that. Introduced through the Secure 2.0 Act of 2022, Pension-Linked Emergency Savings Accounts (PLESA) are a significant development to improve the lack of emergency savings. While savings accounts have always been available, the new law allows them to be added directly to employer-sponsored retirement plans. We think that could make all the difference in widespread access to short-term savings for employees.
PLESA’s integration of emergency savings marks a significant step forward in addressing the financial security concerns of American workers by providing a streamlined approach to both short-term and long-term savings within existing employer-sponsored retirement plans.
PLESAs are available for qualified defined contribution plans, such as 401(k) and 403(b) plans. If a plan sponsor chooses to adopt the PLESA option, this will allow non-highly compensated employees to contribute to PLESAs and make monthly withdrawals (up to 4 per year penalty-free). These accounts entail specific requirements: only employee contributions are allowed, contributions are subject to Roth treatment, and a contribution limit of $2,500. After the employee’s sidecar account balance reaches $2,500, any additional contributions are directed to their retirement plan. To learn more about PLESA’s specifics, view this great summary from Mercer.
Although allowed through the provision, it’s important to note that the platforms to add these accounts have not been developed yet. There is notable resistance from major recordkeepers to adding these accounts, due to administrative burden and increased costs. Despite the Department of Labor’s (DOL) recent guidance, there are still unanswered questions about implementation, causing legal practitioners to be leery of unintentionally making a mistake. More answers are needed regarding several key considerations, such as eligibility criteria, contribution rules, automatic enrollment, and withdrawal procedures.
Pension Consultants, Inc. wholeheartedly endorses the PLESA provision as a pivotal step toward helping American workers. While it will take time to catch on, we believe this is an important evolution for 401(k) plans. Here are our top 5 reasons we believe PLESAs are a great idea.
Secure 2.0 Act’s Emergency Savings Accounts (PLESA): The Most Important 401(k) Development Since Auto Features?
PLESA’s integration of emergency savings into 401(k)s marks a significant step forward in addressing the financial security concerns of American workers by providing a streamlined approach to both short-term and long-term savings within existing employer-sponsored retirement plans. Read about the benefits and features of the new legislation.
5 Reasons Why Emergency Savings (PLESA) Just Makes Sense
Traditional approaches to emergency savings have often fallen short of effectively addressing the financial insecurities of American workers. Despite the availability of various savings options, many Americans still struggle to build emergency funds on their own. This challenge stems from numerous factors, including a general human tendency to prioritize current needs over future needs. As a result, a significant portion of the population remains vulnerable to financial shocks and lacks the necessary resources to weather unexpected expenses.
Secure 2.0’s PLESA provision presents a promising solution by aligning emergency savings with existing payroll deductions through retirement contributions. This innovative approach not only streamlines the saving process but also incentivizes individuals to prioritize financial resilience, ultimately helping them achieve greater financial security.
The Benefits of Integrating Emergency Savings into 401(k)s
#1
- 401(k) is Popular and Well-Established as a Savings Platform
- With millions of Americans already utilizing 401(k) accounts as a primary vehicle for retirement savings, integrating emergency savings options directly into these plans expedites the saving process and leverages existing participation and contribution mechanisms. By capitalizing on the familiarity and widespread adoption of 401(k) plans, the integration of emergency savings represents a potentially seamless and effective way to make a difference in savings among employees.
#2
- Existing Infrastructure Enables Built-In Savings Resilience
- The existing infrastructure of 401(k) plans provides a robust foundation for integrating emergency savings. With established systems for payroll, recordkeeping, investments, and withdrawals already in place, 401(k) plans offer a proven framework that can accommodate the inclusion of emergency savings features.
#3
- Payroll Deductions: Out of Sight, Out of Mind
- The integration of emergency savings into 401(k) plans leverages the psychological principle of “out of sight, out of mind” associated with payroll deductions to enhance savings behavior. We know it works. By automatically deducting contributions from employees’ paychecks and directing them toward both retirement and emergency savings accounts within the same plan, individuals are less likely to perceive the reduction in income. This helps emergency savings accumulate consistently over time, without requiring conscious or strenuous effort or decision-making from participants.
#4
- Automatic Enrollment and Match Opportunity
- Automatic enrollment and matching opportunities within 401(k) plans may amplify the effectiveness of integrating emergency savings. Employers can elect to automatically enroll participants into this account at rates up to 3%. Once your employee reaches $2,500 in the emergency savings account, any additional deductions will be directed into the retirement plan. By automatically enrolling participants into both retirement and emergency savings accounts, employers can assist with consistent contributions and reduce plan leakage.
- Matching contributions incentivizes employees to prioritize emergency savings, optimizing their contributions and accelerating savings growth. When both are utilized, this dual approach maximizes the potential for participants to build substantial emergency funds, bolstering their financial security in the long run.
#5
- Enhanced Security: Fiduciary Oversight and ERISA Compliance in 401(k) Plans
- Fiduciary oversight and adherence to ERISA standards reinforce the integrity and reliability of integrating emergency savings into 401(k) plans. As watchdogs of the plan, fiduciaries can help ensure compliance with government regulations and uphold higher standards of conduct, safeguarding participants’ interests.
The Takeaway
The introduction of PLESA marks a crucial advancement in tackling the financial uncertainties encountered by American workers. However, more guidance from the Department of Labor (DOL) and the Internal Revenue Service (IRS) is important to ensure its successful implementation.
We acknowledge that widespread adoption is necessary for PLESA to be effective across the population. Despite resistance from recordkeepers due to its lack of profit potential, and administrative implications, we urge fiduciary committees to advocate for the inclusion of this feature in retirement plans. These accounts are going to have to be bought by plan sponsors, not sold to them, further emphasizing the importance of demanding implementation.
We firmly believe that supporting PLESA is essential for the long-term financial well-being and security of individuals. As updates from the DOL and IRS continue to shape the landscape, it is imperative that stakeholders recognize the significance of PLESA and actively work towards its adoption for the benefit of all.
Read about the most recent updates to PLESA from the DOL and IRS to learn more.
Should You Adopt Emergency Savings into Your Plan?
PCI believes that the PLESA provision is a step in the right direction toward helping Americans become more financially secure. While it may seem like a small difference, it can make a huge impact in helping your workers.
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