ESAs and retirement accounts: why employees need both

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Devin Miller
September 9, 2022

Emergency savings and financial wellness programs can’t replace retirement savings, but they can help protect retirement accounts. 

An emergency savings account cannot replace a retirement account, but it can complement and protect one. While these two accounts share some similarities, they play very different roles in workers’ lives. In both cases, an employer is helping their employees save money. 

By setting up retirement and emergency savings accounts funded by automatic withdrawals, employers assist their employees in getting past the first hurdle of saving – finding extra money. Almost all financial advice echoes the idea that saving is easier if it’s automatic and uses “invisible” money. Once the money is in hand, it becomes harder to save. 

However, there is a significant distinction between these two savings accounts. An emergency savings account (ESA) is for short-term emergencies, while a retirement account is for long-term needs. Employees need both. An emergency savings account cannot supplant a retirement account, but it can supplement and protect it. If employers want their employees to be ready for retirement, they need to combine retirement account offerings with ESAs and financial wellness initiatives

Americans are not prepared for retirement.

Many U.S. adults are not ready for retirement. Some have no savings, while others know their retirement accounts won’t cover the cost of living during retirement. Even retirement accounts that seem to have large balances don’t offer the financial security people need as they approach retirement. 

The median balance for workers ages 55 to 64 is $120,000. While this may seem like more money than many people can imagine, when you break it down it’s only enough to provide $1,000 per month for 15 years of retirement. That’s below the poverty line, and it leaves absolutely nothing if the retiree lives past age 80. 

This can be frustrating for the average worker. Whether they have nothing in their retirement savings, or just not enough saved, they may start to wonder why they’re putting in those long, hard days just to scrape by and still worry about the future. 

This sense of despair grows when they don’t have emergency savings. They start worrying about both short-term and long-term financial needs. The shift from defined benefit to defined contribution plans may be adding to their stress as well.  

Traditional approaches to employer-sponsored savings 

Traditionally, employers have helped employees prepare for retirement, and employees handled emergencies on their own. The most common option was a defined benefit retirement account, such as a pension. Employees knew if they put in the years at their company they’d have ample resources when they retired. 

Then the benefits landscape pivoted from defined benefit retirement accounts to defined contribution retirement accounts. Defined contribution plans simplified retirement savings for employers – they’re easier and less expensive to manage than defined benefit plans. But for employees, defined contribution accounts such as 401(k)s don’t offer the same level of stability or predictability as defined benefit plans. 

This continues to play out in the numbers. Research from PWC suggests there is a 17% gap between access and participation rates for defined contribution plans. That’s five times higher than the access–participation gap for defined benefit plans. 

But this doesn’t mean that employers should switch back, and most employers wouldn’t choose that option anyway. But it does mean that employers may need to put additional programs in place if they want their employees to be prepared for retirement. This includes both financial literacy programs and emergency savings accounts. 

Why employees need more financial literacy

Defined contribution plans pass most of the responsibility of retirement savings from employers directly onto employees’ shoulders. Employees live in a complex financial world. They often don’t understand the differences in types of retirement accounts, tax planning, and risk management strategies. They don’t feel confident about making retirement decisions on their own, and they often feel they simply can’t afford to save.

What they do know is that they don’t feel prepared for retirement. They know they don’t have enough money in savings or available on credit to cover emergency expenses. They know the Social Security system is in trouble. They know the retirement age is getting younger and healthcare is getting more expensive. This is the perfect storm for stress. 

Financial wellness programs play a key role in preparing employees for retirement 

Employers cannot handle everything. They can’t fix the Social Security crisis or help their employees deal with every aspect of rising inflation or financial stress. But they can address elements that are within their control, including financial literacy and saving for short-term goals. 

Financial wellness programs help narrow the gap between access and participation in retirement accounts. Employees are more likely to save when they understand the advantages of compound interest and tax-free retirement contributions. When employers offer more guidance, such as a financial wellness advisor or digital-led advice, and help them understand the basics of retirement planning, employees are better prepared to make savings decisions that are best for them.  

Beyond that, employers need to look at the financial hurdles that prevent their employees from saving. For instance, if they have workers who are struggling to repay student loans, they may want to offer a student loan paydown program so these workers don’t have to choose between paying loans or saving for retirement. Or if they have workers who regularly use their retirement account balances to cover short-term emergencies, they could offer emergency savings account programs. In all cases, it’s critical for employers to understand the unique needs of their workforce and develop benefits plans that make sense.

Lack of emergency savings hurts retirement accounts.

Many Americans don’t have the funds to cover a basic short-term emergency. If they need a home or car repair, for example, they don’t have the cash on hand to cover it. Without liquid savings, they often make financially damaging decisions to take care of an emergency. Some put strain on relationships by borrowing from friends and family. Others push off monthly bills so they can cover the emergency. 

Those who have cash savings often don’t want to see their balances dwindle, so they put the expense on a credit card. According to the Federal Reserve, the practice of carrying low-interest savings with high-interest debts is growing, and it’s losing Americans money. 

Some employees are even withdrawing funds from their retirement accounts to cover unexpected expenses. Households with at least $1,000 in savings are half as likely to withdraw funds from their retirement accounts as households with no savings. According to the Consumer Financial Protection Bureau, approximately 59% of retirement account holders without emergency savings tapped into their retirement accounts in 2021. The number was only 9% for households that had both emergency and retirement savings. 

This doesn’t just affect your employees. It also affects your organization. Employees without savings are stressed so they’re more likely to be distracted and unproductive at work. And repeated withdraws or loans against retirement accounts increase your administrative burden. 

When your employees have financial wellness, they have less stress and are more productive. They’re also healthier, happier, and more likely to stay with your organization. Retirement accounts alone are not enough. You need to pair them with resources that support your employees, such as emergency savings accounts and financial wellness support. To learn more, contact SecureSave today.

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Devin Miller

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