As a wise, NYU Stern School of Business Professor named Scott Galloway once said, “[t]he most powerful forward-looking indicator of your financial freedom is not how much you earn, but how much you save.” But saving, like weight loss, is difficult. Everyone knows how it works, but very few succeed at it consistently over the long term. Employers are increasingly leveraging their role as paymaster to help employees save, before they have a chance to spend, with after-tax emergency savings accounts (ESAs). In an ESA, employees defer a portion of their pay just as with a 401(k) plan, but with after-tax funds (ESAs can even be established as a “side car” to a 401(k) plan). Employers send after-tax funds to a savings account on which employees can draw to deal with unexpected or planned expenses.
What are some key takeaways for employers who may be thinking of adding this option to their employee benefit menu?
1. Make it voluntary.
Auto-enrollment ESAs are a thing, but state wage and hour laws governing payroll deductions may pose obstacles. Also, prior financial demands such as student loans, high-interest credit cards, and child support obligations may prevent some employees from participating. Making an ESA voluntary does not mean, however, that you need to be passive. In your enrollment materials, include a “suggested” savings rate of a meaningful percentage of pay, and illustrate what it would amount to over 18 months or so of steady accumulation (and compound interest).
2. Think of it as an adjunct to your retirement plan, not an obstacle.
Employers may hesitate to add an after-tax emergency savings account when their employees are not taking full advantage of their after-tax 401(k) or other retirement plan, or have a high number of 401(k) plan loans or hardship withdrawals. This is a valid concern, but employers should not assume that it is a zero-sum equation. Short-term cash crunches are what are driving those plan loans and hardship withdrawals, and may be depressing employee salary deferrals as well. By equipping employees with a way to save money for short-term needs, an ESA may actually make them better long-term savers under the qualified plan.
3. Consider a matching contribution.
Just as with a 401(k) plan, “free money” in the form of employer matching funds will encourage employees to make use of an ESA. Consider whether you want to match a percentage of every after-tax dollar saved, or provide a matching contribution only when certain savings targets are reached, in order to incentivize participation in the ESA over time.
4. Ensure ease of access to savings.
The secret sauce of ESAs is ease of access to the funds when the inevitable unexpected expense arises. This is to be contrasted with participant loans or hardship withdrawals from a 401(k), both of which require a significant amount of paperwork and hence which can take days or even weeks to process. Work with a vendor to ensure that employees can have access funds quickly and easily through electronic transfer or debit cards, and that details about their withdrawals are not available to you as employer. De-identified data about withdrawals, if available from your vendor, however, may help you better design your ESA for your employee population.
5. Supplement with other financial wellness tools.
If you implement an ESA, supplement it with other financial wellness tools that may be on offer, including from your 401(k) recordkeeper. The short-terms savings that an ESA can make possible are only one part of the picture; long-term savings and budgeting are equally important. If an ESA is successful, it will make employees feel more empowered about their financies and hopefully a more receptive audience to the lessons financial wellness modules can impart.
The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2021 Christine P. Roberts, all rights reserved.
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