Top of Mind Mailbag: Emergency Savings Accounts
In response to last week’s Top of Mind post on the merits of Automated Emergency Savings Funds, a reader shared a decidedly different viewpoint, which is worth sharing with our readers. He noted that, in general, those who are unprepared for an emergency are also less likely to be saving enough for other goals. So, by helping these individuals establish an emergency savings plan, plan sponsors are actually diverting funds that could be saved for retirement. He recommended that plan sponsors should encourage participants to take the same funds they would deposit in an emergency savings account and allocate them to retirement instead. Of course, from a tax perspective, this makes a lot of sense—why save in a taxable account when you can save in a tax-deferred one?
In addition, the reader argues that retirement plans already provide for the same short-term liquidity needs that an emergency saving account does, through the use of retirement plan loans. Thus, if I am following his argument correctly, the need for an emergency savings account is mitigated, at least somewhat, by retirement plan accounts. Finally, the reader points out that we already have such vehicles—for example, after-tax contributions have been allowed in a number of retirement plans for many years, with little to no employee interest. Thus, plan sponsors who divert resources from promoting retirement plan participation to emergency savings account participation are wasting their time.
While I believe these views have merit - and have certainly given me food for thought - I can’t say that I am sold on the idea that automated emergency savings funds are a poor benefit for a plan sponsor to offer. First of all, most employers offer a range of voluntary benefits, and I certainly think that an automated emergency savings benefit would be well-received. Secondly, this type of benefit takes minimal effort and investment on behalf of the plan sponsor. And finally, even if only a few employees used the automated emergency savings benefit, it has the potential to dramatically improve these individuals’ financial situations.
Personally, I doubt that anyone is going to stop saving for retirement in order to start an emergency fund, since the point of these funds, like a retirement plan, is to take money out of your account before you have a chance to miss and/or spend it and save it for a future date. I agree that, by offering such a benefit, some people who are not currently saving for retirement plans may opt to start an automated emergency fund, since the process to initiate savings is easier than, say, completing a salary reduction agreement for a retirement plan. However, by improving an employee’s overall financial health through the establishment of an emergency savings fund, I believe that a plan sponsor is improving that employee’s capacity to save for retirement in the future.
Finally, to address the idea of a retirement plan loan serving the same needs as an emergency fund – while that may be okay for the first time, what happens when an individual has exhausted his/her loan availability? Hardship withdrawals are not always available and can be a terrible option, at any rate. And loans are often destructive to retirement wealth building, as many borrowers take funds at the worst possible time—early in their careers, where the power of compounding is the most magical! All in all, I think borrowing from one’s retirement plan is a poor substitute for an emergency savings fund.
Regardless of my opinion, there are clearly some alternative thoughts on this topic. What are yours?
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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