It’s no secret that Americans are worried about having enough money set aside for retirement, with the Federal Reserve reporting that less than 40 percent of non-retired adults believe they are “on track” with their retirement savings. At the same time, only about 60 percent of Americans have enough savings to cover a $400 emergency expense.
Americans experience more stress and worry today than at any other time in recent history, according to a new survey by Gallup. In fact, the research firm’s annual poll found that 55 percent of Americans experience stress “a lot of the day” and 45 percent felt worried. Personal finances play an important role in these negative emotions, with 68% of the poorest Americans saying they had a lot of stress, although it is a problem across all income levels.
I grew up in a working-class family and some months it was easier than others to make ends meet, especially when there was an unexpected expense, such as a major car repair or medical bill. Fortunately, my father’s employer offered a payroll deduction savings account (and this was back in the 1970s!) to let employees set aside a small amount from every paycheck. To this day, I still recall the times when my parents had to discuss using that emergency savings account to help pay an expected or important expense that they did not anticipate. While it may not have removed all their stresses and worry, that account was the difference between a temporary financial setback and a more-disruptive financial crisis for our family.
Retirement Savings Can’t Be Addressed in Isolation
If we want to solve the retirement savings crisis in this country, we can’t ignore the importance of addressing savings more broadly. If efforts to help workers save for retirement are going to be effective, it will only be possible by taking a more holistic view of financial wellness into consideration. Employers, the financial services industry, and policymakers must recognize the dual challenge and develop more flexible approaches that will allow individuals and families to address unanticipated needs while saving for retirement.
Just as the public and private sectors have been working to make it easier for workers to save for retirement, similar efforts must be undertaken to make it just as simple to set aside rainy-day or emergency funds. If we can alleviate some of the worries that Americans have about next week or next month, it will be easier to help them get comfortable with putting away an appropriate amount of savings for their retirement years.
Emergency Savings Accounts Can Help Preserve Retirement Savings
An emergency or rainy-day savings account represents a smart approach that ties together long- and short-term savings. While a traditional 401(k) style account may be the main engine for savings, a parallel rainy-day account can be used to set aside emergency funds for all of those unexpected expenses that we all face at one time or another.
Having access to liquid funds in these accounts not only reduces near-term worry and stress, but it also minimizes more lasting impacts from these financial challenges. Too often, Americans find themselves turning to credit cards or, even worse, payday lenders to cover surprise bills. Using debt for emergency expenses carries additional risk because of the associated interest costs.
Even more concerning is when a worker feels the need to withdraw money from a retirement savings account to pay for more immediate needs. Although hardship withdrawals are only a small proportion of the leakage from retirement accounts — a 2009 GAO report cited 3% of 401(k) participants made hardship withdrawals (with cashouts the more common way retirement savings can be lost) — they can still be a costly way to address financial hardship. A Boston College study determined that a 1.5% annual leakage of funds from an individual’s retirement account during their working years has the potential to reduce by 25% the accumulated wealth for retirement. That underscores just how great an impact a short-term emergency spending can have on retirement savings and long-term financial security.
How Emergency Savings Accounts Work
To address the savings challenge comprehensively, workers should have access to emergency or rainy-day accounts that can be established separately or be part of or sit alongside their retirement savings plans. That way, workers can be contributing to both their emergency accounts and their retirement accounts at the same time. The typical arrangement funds the emergency savings account first, up to a predetermined level, with after-tax income, and directs pre-tax funds into the retirement plan after the emergency funding level has been met. The target for the emergency fund could be set to a recommended three months of expenses or any other amount the worker specifies.
The reality is that it doesn’t take a lot to make families more financially secure. The Urban Institute found that as little as $250 to $750 in emergency savings allows families to handle many unexpected situations with less stress. Access to these funds also means that there is less reliance on credit cards or payday loans.
Time for Action is Now
While Congress has been looking at changing the law to make access to emergency savings even easier, there’s no reason that retirement plan providers can’t already offer solutions. Legislation could enable auto-enrollment in emergency savings accounts, but nothing prevents plan providers and employers from offering voluntary solutions in the meantime.
Some providers have already begun to make convenient solutions available to workers. Prudential Financial has begun to introduce a solution in partnership with employers that directs funds to retirement savings only after the emergency fund has reached a pre-set level. At the same time, employers also are exploring new ways to offer their workers access to rainy-day savings accounts.
Workers want help in meeting their emergency savings needs. In fact, the AARP found that 71% of Americans said they would take part in a payroll-deduction emergency savings program if it was offered to them. That level of receptivity suggests that if employers and financial providers give easy access to these solutions, we would see a rapid improvement in the short-term financial preparedness of Americans.
Prepare for the Future by Preparing for Today
Addressing the emergency savings crisis today will help to alleviate stress and worry now, while better positioning American workers to prepare for retirement. I know that this can work. Because my father’s employer made it possible for him to put away $25 a week, it made all the difference for our family being able to get through some unexpected financial turbulence. It can do the same for families today — if more employers and the financial industry work together to offer simple solutions like rainy-day savings accounts.
Just as state policymakers and employers have made progress in the past few years toward making it easier for more workers to have access to ways to save for retirement, this effort to boost retirement savings will be made even more effective if they also consider ways to address the reality of short-term financial emergency needs and add funding rainy-day savings accounts as an option as well. Establishing emergency or rainy-day savings accounts that work alongside retirement savings accounts is one concept for accomplishing this goal.
At a time when the worry and stress of Americans are at all-time highs, we must recognize that short- and long-term savings challenges go hand-in-hand and find innovative approaches that solve both. The improvement in long-term financial outcomes for individuals and families will be significant.