Client Service July 26, 2022

Pandemic’s Wake Draws Emergency Savings Accounts Into Focus

The pandemic and its impact on the global workforce have underscored the importance of—and increased demand for—a backup plan for unexpected expenses.
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Art by Bill Mayer


Myriad financial lessons can be learned from the COVID-19 pandemic, but one of the most important lessons concerns the value of an emergency savings account alongside a retirement account.

Not surprisingly, a growing number of retirement plan recordkeepers are offering their plan sponsor clients the ability to directly link emergency savings accounts for employees with the company’s payroll deferral retirement plans.

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“The pandemic increased awareness of the importance of emergency savings accounts for both individuals and employers,” says Rachel Weker, a senior retirement manager at T. Rowe Price.

Weker says there wasn’t such widespread use of pandemic-related distributions among participants as many had feared. However, few of those who took distributions have repaid them, Weker says, and these people will feel the impact of these distributions in reduced retirement account balances.

Weker adds that plan sponsors gained a clearer understanding of emergency savings challenges during the pandemic. She feels employers are now more likely to prioritize emergency savings as part of their financial wellness programs.

According to David John, a senior strategic policy adviser at the AARP Public Policy Institute, one result of the pandemic has been that individuals now understand that they need emergency savings.

“Individuals who had emergency savings tended to fare much better than those who didn’t,” he points out. “As a result, this is now a much higher priority than it would have been in 2018 or 2019.”

Automation and Simplification Are Key

For plan sponsors who want to offer an emergency savings option, it is important to automate and simplify the process, Weker says. Otherwise, employees may struggle with getting started in terms of establishing an account and knowing how much they need—or how much they can afford to save. She also warns that many employees are struggling to recognize that they can save more than they currently are, and that it is important for them to look at spending patterns with an honest eye.

According to Weker, retirement plan emergency savings considerations should include the speed at which funds could be accessed, as same-day access to funds typically isn’t available, and the taxation of contributions and distributions. She also says it is important to consider the potential for additional leakage from the retirement plan, as participants might be more likely to tap into retirement plan assets if the emergency fund doesn’t truly meet their emergency needs.

In March, a group led by the AARP Public Policy Institute and the nonprofit Aspen Institute published a set of principles for effective emergency savings policies. The group developed the following five design principles they believe policymakers should follow when implementing emergency savings policy:

  • Allow for automatic enrollment in workplace emergency savings;
  • Ensure emergency savings are their own “bucket” of savings;
  • Allow for a wide range of options, particularly for low-to-moderate-income households;
  • Design emergency savings to meet household needs; and
  • Safeguard retirement savings.

The Importance of Automatic Enrollment

A growing body of research shows that automatic enrollment in employer‑sponsored 401(k) savings plans has had a huge impact on the way millions of Americans save for retirement. Inertia seems to be stopping many workers from signing up for company retirement plans, as a desire to save doesn’t always translate into action.

“As seen with the retirement plan experience over the years, auto-enrollment can be an effective way to encourage savings by harnessing inertia and removing traditional barriers to getting started on a savings path,” Weker says.

However, research also shows that auto-enrollment is better at increasing participation than it is at increasing overall levels of savings. An analysis from T. Rowe Price and Taha Choukhmane, an assistant professor of finance at the MIT Sloan School of Management, indicates that auto-enrollment programs set up without automatic deferral escalations tend not to have a strong positive impact on financial outcomes. This is because employees who are auto-enrolled tend to contribute less than those who are not.

Separating Emergency Accounts From Retirement Plans

According to John, behavioral studies on investing habits show that people are far less likely to dip into their emergency savings for other things if they are in a separate account.

“There is a study that has been widely quoted which addresses something called ‘envelope theory,’ and what it basically shows is that people are less likely to touch assets when they are held in an account with a stated, particular purpose,” John says. “The takeaway is that people need an emergency savings account and one that is different from their general savings.”

According to a research paper from the National Bureau of Economic Research, 39% of U.S. adults said in a survey that they could not pay for a $400 emergency expense using cash or its equivalent.

“With limited liquidity, many working-age households spend savings intended to finance old-age consumption well before reaching retirement,” the paper warns.

The analysis attributes these spending patterns to several behavioral biases, including what is known as present bias, which is the tendency to overweight the present relative to the future.

“Individuals with present bias tend to act impatiently in the present while wanting to act patiently in the future,” the report explains. “Households with present bias hold too little liquid wealth and will deplete their partially liquid retirement savings (e.g., through 401(k) loans or pre-retirement distributions) when adverse shocks arise.”

Provide a Range of Options to Ensure Needs are Met

According to the set of principles for effective emergency savings policy, supporting only one type of emergency savings account could exclude certain households that are in desperate need. Put simply, the needs of different groups are going to vary widely.

Additionally, emergency savings should be enough to meet a wide range of financial needs when income alone is insufficient. Some research indicates that the minimum liquidity buffer needed by the average low-income household is just under $2,500, and can be as high as more than $3,000.

According to the Aspen Institute, households with at least $1,000 in emergency savings were half as likely to withdraw from their workplace retirement savings accounts during the pandemic. Such an account can replace the need to use retirement withdrawals or loans and may reduce the number of people who regularly withdraw early from retirement savings.

“A significant number of employers are now recognizing that this is something that their employees want,” says John. “We are still seeing a relatively small number of employers actually offer emergency savings accounts, but we are seeing that this number is growing. And that is likely to spur even more innovation going forward.”

Data & Research July 26, 2022

Emergency Savings Preparedness and Perceptions

According to EBRI, workers with household incomes of $75,000 or more are more than twice as likely to say they feel they can handle an emergency expense than those with household incomes of less than $35,000.
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Art by Bill Mayer


Each year, the Employee Benefit Research Institute publishes an updated Retirement Confidence Survey, which the research and advocacy organization bills as the longest-running survey of its kind.

The 2022 survey polled nearly 2,700 Americans early in the year. All respondents were age 25 or older, and the survey included 1,545 workers and 1,132 retirees. Among the specific areas examined in the 2022 edition of the survey was emergency savings and the level of preparedness workers feel when it comes to their ability to handle unexpected expenses.

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According to EBRI, Americans feel relatively well prepared for emergency expenses, at least at the aggregate level. Specifically, two-thirds of workers and three-quarters of retirees either strongly or somewhat agree with the statement that they feel they have enough savings to handle an emergency or sudden large expense.

While this figure appears reassuring, a closer look at the data reveals a more concerning picture. In fact, the 2022 survey report notes that workers with household incomes of $75,000 or more are more than twice as likely to say they feel they can handle an emergency expense than those with household incomes of less than $35,000. Expressed in another way, 78% of the higher income group feels well prepared for an emergency expense, compared to just 35% for those making less than $35,000 per year. According to EBRI, a similar gap exists between higher income workers saying debt is not a problem and lower income workers saying it is a major problem.

EBRI’s analysis shows the same income-based confidence gaps exist among retirees. Specifically, nine in 10 retirees who say that debt is not a problem feel they have enough savings to handle an emergency or sudden large expense. Among those retirees who say debt is a major problem, just 16% feel prepared for unexpected expenses.

The survey results show a little more than a third of workers and a little less than a quarter of retirees agree that long-term retirement savings is not a priority relative to the current needs of their family. Again, workers and retirees who have the lowest incomes (less than $35,000) and accumulated savings (less than $10,000) and have a major problem with debt are more likely to agree with this statement than those with highest incomes, the most savings and the lowest debt. Also, according to EBRI’s analysis, workers younger than age 45 are more likely to agree with this assertion than workers ages 45 or older.

A related report released earlier this year by the Defined Contribution Institutional Investment Association and Commonwealth gives insight into the progress the retirement industry has made on developing and implementing emergency savings solutions.

“Retirement Industry Leaders on Emergency Savings” notes that while emergency savings solutions may vary in their exact approach, one clear takeaway is that adequate emergency funds are an important part of financial wellness and financial security. The solutions currently in place and those that are being created are guided by two key insights, the report adds. The first insight says that emergency savings should be their own “bucket,” meaning funds are placed in an account that is distinct from funds intended for long-term retirement savings. The second insight says that well-designed emergency savings accounts are effective buffers against early withdrawals from retirement savings.

“Ideally, public policy will be supportive of further evolution in emergency savings solutions by providing clarity to plan sponsors, recordkeepers and other providers as to important guidelines and best practices,” the report says. “One significant development would be explicitly allowing for automatic enrollment into emergency savings vehicles.”

The report found that the general consensus is that emergency savings solutions should enable short-term savings with liquidity and preserve long-term savings. Most of the solutions highlighted in the report offer a dedicated account distinct from retirement savings that is either outside of the retirement plan as a standalone account or inside of the plan but separate from the core retirement assets.

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