One of the unfortunate truths in American economics is that many households do not have sufficient emergency savings. This becomes especially worrisome during periods of high inflation with the threat of a financial downturn looming. Such a downturn leaves many families vulnerable since they do not have savings to keep them afloat. According to a June 14,2022 publication from the Federal Reserve, 1 in 8 American’s would be unable to pay their current month’s bills if a $400 emergency popped up.
The federal government has recognized this problem and recently proposed legislation to address it. In fact, two proposals are circulating in the Senate which address this issue. Both bills would aim to help households become more prepared for a tumultuous future while also making it easier for these families to save adequately for retirement.
The Need for More Emergency Savings Options for Employees
The new legislative proposals come directly from the impact of the COVID-19 pandemic on American families. When many families suddenly found themselves without an income, they had no savings to fall back on and instead needed to rely on limited government aid that didn’t cover all necessary expenses.
Even now, the pandemic continues to have an effect on the economy. Record rates of inflation and climbing interest rates that can make difficult to make ends meet. Only two years ago, 54 percent of Americans said they were comfortable with their emergency savings. That number has now fallen to 42 percent, according to a report from Bankrate.
Unfortunately, many Americans have dipped into their retirement savings to make ends meet during this period. Doing this comes with substantial financial penalties and can make retirement seem even further away than it was before. Taking money out now means missing out not just on the amount withdrawn immediately, but also the interest that amount would earn in the years leading up to retirement.
For this reason, the federal government has become more concerned with encouraging emergency savings in order to prevent people from withdrawing contributions from their retirement savings early, paying huge penalties, and missing out on market gains. The Senate now has two proposals that link emergency savings accounts to 401(k) plans offered by employers.
The Two Legislative Proposals Introduced by the Senate
Both Senate proposals were approved by separate committees in late June to become part of the evolving Secure Act 2.0. This new legislation builds on the first Secure Act, passed in 2019, to help bolster the American retirement system. Secure Act 2.0 pushes legislation even further to create an environment that encourages saving for the future and aims to set Americans up for a successful retirement.
One of the proposals would allow employers to enroll their employees in a sponsored emergency savings account funded by 3-percent of monthly pay, the most common percentage currently allocated to 401(k) accounts. This account would have a cap of $2,500. After the account limit is reached, the allocations would be would be directed toward a linked employee sponsored retirement plan, much like it is done today. This would automate emergency savings for employees and direct any excess contributions toward retirement savings.
The second proposal approaches the issue from another angle. According to this option, workers would be able to withdraw up to $1,000 from a 401(k) or individual retirement account (IRA) to cover an emergency expense without being subjected to the 10-percent tax penalty for early withdrawal. Under this system, individuals would be able to treat their retirement accounts as a sort of emergency fund without paying a penalty and losing out on even more money.
Of course, this proposal would also mean people could erode their retirement account balances quickly with emergencies. However, some people may see this option as preferable. It would mean all contributions are initially directed toward the retirement account and get to accrue interest in amounts potentially far more substantial than the interest offered by emergency savings accounts.
One of the thought processes supporting the second proposal is that it would encourage people to open a retirement account if they do not already have one. In the United States, many people who have access to a retirement plan through an employer do not take advantage of it. One reason for this may be because these individuals feel that contributing to the account makes the money illiquid and unavailable in the short term, which is largely true. Making it possible to access the accounts for emergencies might make people more likely to open an account and contribute to it regularly. This system builds short-term liquidity into long-term savings in a way that makes saving for the future seem less daunting.
The Path Forward for Secure Act 2.0 and the Two Proposals
The House of Representatives has already passed its own version of Secure Act 2.0. Moving forward, the House and Senate will need to resolve the differences between the versions passed by the two chambers. This may mean that only one or even neither of the new proposals gets included in the final version of the legislation.
The path forward will depend on the votes of our congressional representatives. If you feel strongly, you can always contact your representatives to let them know your stance. If the House and Senate cannot agree on a version of Secure Act 2.0 before the close of the session, it will be back to the drawing board and the issue will be readdressed during the next congressional season.