Emergency Savings Accounts

Since the 1980s, employees have become accustomed to getting help from employers to save for retirement with 401(k) plans. But what about saving for more immediate needs? Now many employers are stepping up to help employees save for unexpected expenses.

Emergency Savings Accounts (ESAs) allow employees to make automatic deposits through payroll deductions—similar to how their 401(k) accounts are funded.

The need for emergency savings became apparent during the COVID-19 pandemic. As businesses were forced to reduce hours or shut down to encourage social distancing, many employees were confronted with the reality of reduced or no income for months on end.

Even before the pandemic, the Federal Reserve’s Report on Economic Well-Being of U.S. Households in 2019 showed that 37 percent of U.S. households could not come up with $400 for an emergency expense if needed.

Experts believe that encouraging employees to contribute a portion of their pay to an emergency savings account can alleviate financial concerns and help employees focus better at work.

Perhaps even more importantly, an ESA can keep employees from seeking loans or early distributions from their existing retirement savings. This is particularly important now since the Coronavirus Aid, Relief, and Economic Security (CARES) Act has made retirement plan withdrawals possible for people who haven’t yet reached retirement age.

The downside of an ESA is that it might cause an employee to put less money into their retirement account.

Employees already have the option to divert a portion of their paycheck into savings. But this is the first time the door is open for employers to auto-enroll employees into savings plans, in a way that’s similar to how they set up a 401(k), with the employee having to opt-out instead of opt-in.

How to Set Up a Savings Account

There are two ways to set up emergency savings account for employees:

• With an existing 401(k) plan used as a “sidecar account,” where the ESA shares the same platform as a 401(k) plan. Once the after-tax cash builds up to a certain point, the employee can request further payroll deductions to be directed into their retirement savings using pretax dollars. One drawback is that it could take a few days for employees to withdraw money from their ESAs.
• With an account at an outside bank or financial institution

Regardless of the kind of account chosen, the employer must decide whether to manage the account. Many employers hire third-party administrators to handle the details. Employers must also decide whether employees need to sign up to participate or if they will be auto-enrolled.

Remember that the difference between ESAs and 401(k)s is that the dollars deducted from employees’ paychecks for an ESA are taxed as income and don’t have to remain deposited long term. Plus, employers can make matching contributions to employees’ accounts.

Federal Guidance

The federal Consumer Financial Protection Bureau (CFPB) addressed uncertainty about whether employers were authorized to set up ESAs. The bureau issued guidance in a Compliance Assistance Statement of Terms (CAST) template.

If you are interested in setting up an ESA that has automatic deposits, you can use the CAST template as the basis for an application to receive the CFPB’s approval to create an ESA.

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