Workplace emergency savings accounts take on the form of in-plan (administered alongside a defined contribution retirement savings plan ) or out-of-plan (administered separately, outside of ERISA compliance). ERISA, or the Employment Retirement Income Security Act, is the federal law that lays out the requirements for employer-sponsored retirement plans.
When it comes to choosing the right option for your organization, understanding ERISA and how it impacts the features of each emergency savings option can make you better informed to determine whether an out-of-plan or in-plan solution aligns best with the needs of your people.
What is a defined contribution (DC) plan?
A defined contribution (DC) plan is a type of retirement savings plan in which an employee contributes a set amount of money, typically through payroll deductions, into a retirement savings account. In a DC plan, the employer may also contribute, typically through matching contributions or profit-sharing. The final benefit to the employee at retirement is determined by the total amount of contributions, investment gains/losses over time, and any fees associated with the plan.
Examples of defined contribution plans include 401(k) plans and 403(b) plans. You typically invest the money itself in mutual funds or target date funds, with an objective of long-term sustainable growth. DC plans are not bank accounts; DC plans are considered investments and, therefore, are not FDIC-insured.
What are in-plan emergency savings?
An in-plan option for emergency savings is an option offered to an employee that works in conjunction with an employer-provided retirement savings plan. Because in-plan emergency savings are tied to a DC plan through an employer, they must abide by the rules and regulations under ERISA.
In-plan emergency savings today
Today, when an employee faces an emergency and needs to take out money out of their 401(k), that employee either typically takes a loan or a hardship withdrawal. Leading retirement savings recordkeepers like Vanguard, Empower, and Fidelity have indicated such loans and withdrawals have been on the rise driven by an increasingly financially vulnerable workforce.
These loans and withdrawals allow for relatively immediate access to funds but often come with limitations or penalties, such as taxes and a reduction in future retirement savings. If someone isn’t yet at retirement age, they may have to pay taxes, principal loss from investment, . Loans may also carry distribution or transaction fees.
In-plan emergency savings under SECURE Act 2.0
SECURE Act 2.0 introduced another way to use retirement in times of emergency: a $1,000 penalty-free withdrawal that must be paid back within three years. To make this withdrawal possible, an equal amount in the retirement investment is sold. This approach treats the retirement savings plan itself as a kind of emergency savings vehicle.
SECURE Act 2.0 also formally established in-plan . Companies can now add ESAs as part of their 401(k) or pension plan, including for the purposes of auto-enrollment and spillover contributions.
Money in ESAs must be principal-protected (it can never decrease in value due to its underlying investment vehicle) and easily accessible. Unlike hardship withdrawals or retirement plan loans, ESAs are designed so that employees don’t incur fees or penalties for withdrawals. Any gains from Secure Act 2.0-compliant emergency savings accounts are not taxable.
What are out-of-plan emergency savings?
Out-of-plan options for emergency savings are any option that’s separate from an employer-sponsored retirement plan; they do not require the employer to offer a retirement savings plan.
Typically, money in out-of-plan emergency savings accounts is stored in banking products, like an FDIC-insured savings account or custodial account, or money market accounts. An out-of-plan emergency savings approach offers more flexibility in terms of access to funds and withdrawal options for the employee and removes the fiduciary responsibility from the employer.
Out-of-plan emergency savings also do not carry any tax benefit nor do they have spillover provisions, meaning employees are not forced to contribute to their retirement savings after a certain threshold. As a result of this separation, out-of-plan are not subject to ERISA rules and regulations (although, other agency rules may apply). This gives employers more options on how to structure a workplace emergency savings program within their current benefits package, and reduces barriers to participation and limitations for workers when accessing emergency funds.
What are the features of an in-plan option?
“The main advantage of [an in-plan] option is that it allows employees to potentially access emergency funds without having to withdraw from their retirement savings,” said Jon Morgan, CEO of Venture Smarter. “Additionally, in-plan options may also be more convenient for employees as they are offered through the same plan as their retirement savings.”
When emergency savings are added as a feature of an employer-sponsored defined contribution plan, the core benefit is building on rails that already exist: it may be initially cheaper to implement if a company already has some kind of employer-sponsored retirement or pension plan that in turn already offers in-plan ESAs. The steps include amending plan documents to add ESAs, adding a corresponding principal-protected fund, and automating contributions and spillovers during recordkeeping.
For organizations without an employer-sponsored DC plan option, setting up an in-plan option is not possible. Before setting up an emergency savings feature, you must set up the retirement or pension plan itself.
Key benefits to in-plan emergency savings
This direct connection between a person’s employer-sponsored retirement account and their workplace emergency savings account results in a few things:
Lower upfront investment: Most recordkeepers currently offer or plan to offer in-plan ESAs for little to no capital expense. This may change in the future as recordkeepers better evaluate the total cost of offering such accounts.
Contribution matches into retirement savings: In-plan allows employers to match employees’ contributions towards emergency savings with employer contributions into their retirement plan, meaning a further tax advantage for both. This could encourage workers to participate first in emergency savings while also building their retirement savings.
Automatic savings: Existing payroll integration means that funds towards emergency savings can be automatically deducted from an employee’s paycheck. Automating savings is a simple way to maintain consistency in building an emergency fund.
Ease into retirement savings: When emergency savings are offered in conjunction with retirement savings by an employer, any funds in excess of an individual’s personal emergency savings goal can be redistributed to an employee’s retirement savings account. An ESA has the potential to act as a springboard for employees to change their savings behaviors/mindsets and ultimately set them up for long-term savings goals like retirement.
Potential drawbacks to in-plan emergency savings
Going with the in-plan route could be cheaper upfront, but can muddle employees’ saving experience, hinder participation, and drive-up support costs. Additional compliance could also add up.
Contribution caps: While in-plan emergency savings options can make it easier for an employer to match employee contributions, there is a $2,500 employee contribution cap. So, say, someone has already maximized their contributions towards emergency savings for the year. Suddenly, they need to withdraw $1,500 to cover the costs of an emergency event. This person can’t replenish that missing $1,500 back into their emergency savings fund.
Restricted portability for workers: When a person ends their employment at a company where they have in-plan emergency savings, they have just two options to take that money with them. They can either 1.) cash out the remaining balance in that savings account or 2.) automatically let that balance funnel into the associated employer-sponsored retirement account and, then, go through the process of transferring those 401(k) assets into a rollover IRA. They can’t simply carry emergency savings over to their next employer or keep the money where it is for easy access down the line.
Muddled user experience: While it may be convenient for the recordkeeper or the employer to centralize the user experience, employees could become confused between how their money is stored, where and how to withdraw, and how much to save. Employers and recordkeepers will need to invest heavily in platform literacy and provide corresponding support services.
Substantial compliance work: For employers, managing an in-plan option requires a heavy lift from your HR and finance teams to make sure that your in-plan emergency savings and overall benefits package follow all ERISA standards and regulations, especially under SECURE Act 2.0. This can look like annual and ongoing reporting to the Department of Labor and IRS, but can often include much more.
Incremental costs to employers: Because of more compliance and support costs, employers cannot assume that an in-plan program is a simple check-the-box.
Limited access for employees: Several companies limit when an employee can access an employer-sponsored DC plan. Usually, this manifests as a waiting period of at least six months before an employee can join a 401(k) retirement plan.
This access limitation also comes in the form of cash access. For in-plan options, it takes roughly between three and five business days for an employee to withdraw funds. In cases of a true emergency, that delay in access to necessary funds can have a large life impact on the employee.
Limited reach: The biggest downside is that an in-plan ESA by definition requires employers to offer a retirement savings plan in the first place, which remains a challenge for small employers and the gig workforce.
What are the features of an out-of-plan option?
“On the other hand, out-of-plan options…are separate from a retirement savings plan. The main advantage of this option is that it allows employees to access emergency funds without having to withdraw from their retirement savings,” said Morgan.
Out-of-plan options for emergency savings are more widely accessible to workers than in-plan solutions since they’re not restricted to individuals who are enrolled in an employer’s retirement plan. This means that organizations without a retirement plan setup can easily implement an out-of-plan emergency savings solution without having to face the complexities associated with having to comply with the standards and regulations under ERISA.
Out-of-plan solutions can come from a variety of sources (banks, credit unions, etc.), giving people wider and more access to a range of products to choose from – whether that’s a high-yield savings account, money marketing account, or whatever else.
Key benefits to out-of-plan emergency savings
Simply: out-of-plan workplace emergency savings options do a better job of improving accessibility to emergency cash for employees, better meeting the point-in-time nature of emergencies. These options fill in the major gaps left by in-plan options:
No caps on contributions: In an out-of-plan solution, workers are free to contribute as much as they want to an emergency fund, though an employer may choose to provide guidelines for per-paycheck maximums.
An out-of-plan emergency savings option can also give employers more flexibility in how they can match employee contributions to drive different savings behavior. For example, we provide the option for employers to provide custom matching or rewards based on the type of worker. So, say, hourly workers can earn 10 percent every quarter in rewards on their emergency savings balances, compared to 3 percent on balances for salaried workers.
Standalone user experience: An out-of-plan program can meet employees where they are and how they think in cases of emergencies or other immediate goals. From a mental accounting perspective, this also means employees are less likely to also touch their retirement savings during withdrawals.
Simple to manage: Out-of-plan emergency savings options have simpler account structures, which make it easier for your finance and HR teams to manage them as part of your benefits package. Additionally, your team doesn’t need to invest time to make sure that it’s under compliance – your out-of-plan provider ensures that their product/service is compliant for use.
Immediate access to cash: The savings deposited into an out-of-plan emergency savings solution are at once accessible. Unlike in-plan options (where employees withdraw or borrow from their retirement accounts), out-of-plan options aren’t connected to an employer-sponsored DC plan, so there are fewer restrictions and shorter waiting periods for withdrawals. For example, with Sunny Day Fund, it can take as short as 12 hours to receive funds from emergency savings – this is a vast improvement to in-plan, where the minimum wait is three business days.
No penalties or taxes: Withdrawals made from out-of-plan emergency savings accounts are not subject to penalties or taxes. Because employees don’t touch the funds in their employer-sponsored retirement accounts, they save money by not paying taxes or fees and they keep their retirement savings intact.
Greater portability between employers: Out-of-plan emergency savings solutions aren’t tied down to a particular employer. This means that after an employee leaves a company, they can still access their emergency savings in the same way that they’d always been able to access it – they face no restrictions or fees whatsoever in pulling from that savings account. If they happen to move to a new employer that offers the same out-of-plan solution, they can easily re-configure their emergency savings and restart contributions through their new employer.
Broader reach: Because the retirement rails are not necessary, out-of-plan emergency savings may be a better fit for smaller, gig-focused, or higher attrition employers.
Potential drawbacks to out-of-plan emergency savings
While out-of-plan options provide many benefits to workers, there are a few things that may be concerning before you decide on an out-of-plan workplace emergency savings solution:
Possibly costlier to initiate: Out-of-plan solutions (offered through a bank or credit union) might require added administrative and implementation expenses as they add new rails to the payroll.
No automatic spillover to retirement savings: Because of the program setup, the same type of spillover effects that exist in-plan (where employee contributions over $2,500 in a given year automatically go to the retirement plan), cannot exist.
Which is better for my organization: in-plan or out-of-plan emergency savings?
Ultimately, whether to offer an in-plan or out-of-plan emergency savings option depends on the specific needs and resources of the employer. Organizations should consider the potential long-term consequences of in-plan options on retirement savings and weigh them against the potential benefits of out-of-plan options.
Whether in-plan or out-of-plan, access to emergency savings can potentially increase participation in workplace retirement plans. This accessibility can also serve as a core driving factor in improving diversity, equity, and inclusion within your organization.
For organizations focused on improving diversity, equity, and inclusion, an out-of-plan solution like Sunny Day Fund may be the better choice. Our Savers aren’t subject to any penalties or fees, and our product works with them as partners in their journey toward long-term savings.