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It’s no secret that households with sufficient emergency savings are the exception rather than the norm.
Two proposals in the Senate aim to change that. And solving the problem could help workers save more for their golden years, experts say.
“One of the best ways to protect retirement savings is to help families manage short-term emergency savings more effectively,” said Angela Antonelli, executive director of Georgetown University’s Center for Retirement Initiatives.
The Covid-19 pandemic has shed light on many workers who were unprepared for the financial struggles that came with the sudden loss of work and income. While generous government aid was aimed at keeping families afloat as the economy recovered, Americans are now struggling with inflation and rising interest rates that are making it more expensive to buy and borrow.
The overall share of Americans who feel very comfortable (13%) or fairly comfortable (29%) with their emergency savings fell to 42% in June from 54% two years ago, according to a recent Bankrate report.
For now some companies offer emergency savings accounts for employees, the Senate proposals have specific parameters and both are related to 401(k) plans.
Offers were approved in separate commissions in late June as part of this chamber’s evolving version of the so-called Secure Act 2.0. The legislation will build on the original Security Act 2019, introducing additional changes in the US pension system in an attempt to increase the ranks of savers and the amount they save for their post-working years.
The first proposal under consideration would allow companies to automatically enroll their employees in emergency savings accounts with 3% of salary that can be accessed at least once a month. Employees will be able to save up to $2,500 in the account, and any excess contributions will automatically go into a linked 401(k) plan account at the company.
Another Senate proposal takes a different approach: It would allow workers to withdraw up to $1,000 from their 401(k) or individual retirement account to cover emergency expenses without having to pay the usual 10% tax penalty for early withdrawals if they are under age 59½. .
Still, a separate account would be the preferable of the two so that people are less likely to withdraw money from their 401(k), Antonelli said.
“It helps prevent the drain on retirement savings,” she said.
Still, for workers who have access to a 401(k) or similar plan at work, but don’t participate in it, having emergency funds may prompt them to enroll in their company’s retirement plan, said Lee Phillips, president and CEO of the nonprofit SaverLife focused on helping households build savings.
“One of the big things that prevents people from participating in long-term savings is a lack of short-term liquidity for emergencies,” Phillips said.
In traditional 401(k) plans, where contributions are made on a pre-tax basis, the account withdrawal penalty is subject to a 10% tax if the individual is under age 59½ (unless he meets an exemption allowed by the plan).
“Some people are worried about the money being locked up and not being touched,” Phillips said.
This concern is addressed in state-sponsored retirement programs, which typically automatically enroll workers — those who don’t have access to a work plan — into Roth IRAs (people can opt out if they choose).
Roth accounts don’t offer upfront tax benefits for contributions like traditional IRAs do, but you can usually withdraw your contributions at any time without penalty for early withdrawal.
The Roth structure “offers more flexibility and more terms to allow someone to tap into those savings when they need to,” Antonelli said.
In all, since 2012, 46 states have introduced or considered legislation to create retirement savings initiatives to cover workers without a plan at work. According to Antonelli’s organization, more than $476 million has been invested in these plans together.
While there are slight differences between state programs, the general idea is that employees automatically contribute to a Roth IRA through payroll deductions (starting at around 3% or 5%) unless they opt out .
It’s unclear whether any of the Senate’s emergency savings proposals will make it into the chamber’s final version of Secure Act 2.0, or whether the approved provision will look exactly like what was proposed.
The The House passed its version of the Secure Act 2.0 in March. It is not known when the Senate may reconsider its implementation. Assuming senators give their approval, differences between their legislation and the House bill must be worked out before the final version can be fully approved by Congress.
If it doesn’t happen this year, the legislative process will start over in the next Congress.