Unpacking SECURE 2.0: The evolution and future of emergency savings account provisions

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Devin Miller
March 14, 2024

The passage of the SECURE 2.0 Act has opened a new chapter in financial preparedness for Americans, offering a promising future for emergency savings accounts (ESAs). With this formal legislation paving a pathway for cementing emergency savings as an employee benefit, the future looks bright for helping individual Americans achieve financial security through workplace ESAs. 

Introduction to SECURE 2.0 and ESA provisions

The SECURE 2.0 legislative framework represents a significant milestone in the ongoing efforts to improve Americans’ financial wellness. At its core, SECURE 2.0 strives to enhance retirement savings and provide a safety net for unforeseen emergencies. 

The broader goals of SECURE 2.0

The history of SECURE 2.0 lies in the original Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was enacted in 2019. The overarching objective is still the same: to empower individuals to achieve financial stability throughout their lives, but SECURE 2.0 adds more provisions to help make this objective more achievable. Notably, the updated legislation addresses Americans’ critical need for emergency savings.

Expansion of ESA access and eligibility

One of the key innovations introduced by SECURE 2.0 is the concept of a “sidecar” emergency savings account, also known as a pension-linked emergency savings account (PLESA), which is designed as a companion to employees’ traditional retirement savings. These types of ESAs are also called in-plan ESAs since they’re built into retirement plans. Here’s how it works:

  1. Voluntary creation: Employers have the option to create a sidecar account linked to an employee’s retirement plan. While this provision is optional, it opens up new avenues for financial preparedness.
  2. Cap and investment rules: The sidecar account has a cap of $2,500, although employers can set a lower limit if they prefer. These accounts must be invested in principal-protected assets, to shield the funds from market volatility.
  3. Auto-enrollment and withdrawals: Employers can automatically enroll participants in in-plan ESAs, contributing up to 3% of their pay, but participants have the ability to opt out and must be informed of this option. The act stipulates that withdrawals are allowed at least once per month, granting quick access to emergency funds.
  4. Concurrent contributions: Participants can contribute to both their retirement account and the in-plan ESA at the same time, with the goal of building retirement wealth while safeguarding against unexpected expenses.
  5. Employer match: Employers can offer an emergency savings match to further incentivize employees to contribute, but it goes directly into their retirement account instead of the PLESA itself. Only the individuals’ own contributions go into the PLESA. 

Simplified hardship criteria and tax treatment

Notably, SECURE 2.0 streamlines the process for accessing emergency funds so that individuals can cover unexpected expenses more easily. Two provisions help facilitate this:

  • Self-attestation: Participants no longer need to provide extensive documentation to prove hardship and can instead self-attest that they meet IRS criteria — simplifying the path to financial relief regardless of the reason for withdrawing funds. 
  • Roth treatment: PLESAs operate as Roth accounts with contributions taxed upfront. But the usual early withdrawal penalties and the five-year waiting period do not apply, offering individuals additional peace of mind that they can access their funds freely without restrictions.

Let’s look at a real-life example: Sarah is a young professional who contributes to her retirement plan regularly but worries about unexpected expenses. With SECURE 2.0, her employer introduces the in-plan ESA. Sarah funds her $2,500 account within several months, and it offers her a safety net later in the year when her car breaks down. She’s able to withdraw funds quickly to cover repair costs without tapping into her retirement savings, protecting her long-term financial security.

Changes in eligibility criteria

While the original SECURE Act primarily focused on retirement savings, SECURE 2.0 expands access to include a broader range of individuals, namely long-term part-time employees.

Previously excluded from many employer-sponsored retirement plans, part-time workers now have an opportunity to participate in ESAs. Under the updated act, part-time employees who have worked at least 500 hours during a consecutive two-year period are eligible to participate in the employers’ 401(k) plan. This offers an important avenue for historically excluded workers to achieve financial stability.

Automatic enrollment and contribution escalation

Another notable change is that the act encourages organizations to automatically enroll eligible employees in ESAs – with the ability to opt out. This move is intended to help employees start saving more money earlier, which could alter the trajectory of their financial well-being.

SECURE 2.0 encourages proactive savings behavior through:

  • Automatic enrollment: Employers can automatically enroll employees in ESAs, making it the default option unless they opt out. This behavioral “nudge” ensures that individuals start building emergency savings without active decision-making. Research shows that automatic enrollment significantly boosts participation rates. Principal Financial Group found that 80% of employees who were automatically enrolled in their workplace retirement plan started saving for retirement earlier than if they had decided to on their own, and 65% increased their savings. 
  • Gradual escalation: Participants have the option to increase their ESA contributions over time, particularly as they earn salary increases or other milestones. This flexibility ensures that individuals’ emergency savings keep pace with changing life circumstances.

Employer-sponsored ESA programs

SECURE 2.0 also opens doors for ESAs to be integrated within employer-sponsored retirement plans. This integration is intended to streamline benefits packages and make workplace benefits more attractive to workers, which can benefit both employers and employees.

SECURE 2.0 encourages employers to integrate ESAs into their retirement plans with the advantages of:

  • Enhanced employee benefits: Offering ESAs as part of workplace benefits enhances an employer’s appeal, signaling a commitment to employee financial well-being beyond just retirement.
  • Reduced financial stress: Employees facing unanticipated expenses can turn to their emergency fund instead of taking out loans or using credit cards. This helps minimize financial stress in times of crisis. 
  • Attracting and retaining competitive talent: Employers who prioritize financial security are more competitive at attracting and retaining top talent. ESAs can be a powerful recruitment tool, especially for younger workers who value flexibility and holistic benefits.

Tax incentives and contributions

Adjustments to tax incentives related to ESAs are a key feature of SECURE 2.0, helping motivate individuals to prioritize their emergency funds. There is a strong potential that these provisions will help foster a healthier financial ecosystem where personal savings rates see a steady climb.

These new tax incentives include:

  • Saver’s Credit enhancement: The existing Saver’s Credit, which rewards low- and moderate-income individuals for retirement savings, now extends to ESAs. This credit provides a direct tax benefit, encouraging active ESA participation.
  • Employer matching incentives: Employers who match ESA contributions receive tax benefits. This encourages more employers to adopt ESAs, benefiting a greater number of employees.

Integration with other financial products

The provisions of SECURE 2.0 also encourage the alignment of ESAs with other financial products, recognizing that financial well-being isn’t compartmentalized but instead is interconnected. Here’s how ESAs integrate with other financial products:

Synergy with retirement accounts

SECURE 2.0 encourages employers to align ESAs with existing retirement accounts. This offers notable benefits:

  • Contributions coordination: Participants can allocate a portion of their paycheck to both the ESA and the 401(k) – a coordinated approach ensures that emergency savings grow alongside retirement funds.
  • Tax efficiency: By contributing to both accounts, individuals also optimize their tax strategy. While traditional 401(k) contributions reduce taxable income, Roth ESA contributions provide tax-free withdrawals during emergencies – offering the best of both worlds.
  • Liquidity bridge: ESAs act as a liquidity bridge. When unexpected expenses arise, individuals tap into their ESA without penalties and avoid disrupting long-term retirement planning. 

Synergy with Health Savings Accounts (HSAs) 

When health and wealth are both strong, people are set up to thrive. ESAs and HSAs complement each other through:

  • Triple tax advantage: Contributions are not only tax-deductible, but earnings grow tax-free, and withdrawals for qualified medical expenses are tax-exempt. Integrating ESAs with HSAs extends this advantage to emergency funds.
  • Emergency health costs: Unexpected medical bills often strain finances. An ESA-HSA duo provides a buffer. If an individuals’ ESA isn’t enough, they can dip into the HSA for health-related emergencies.
  • Long-term health planning: While HSAs primarily focus on health expenses, they can serve as a long-term savings vehicle. By integrating ESAs, individuals prepare for both health crises and general emergencies.

Flexibility in ESA withdrawals

SECURE 2.0 recognizes the importance of easy access to ESA funds by allowing flexible withdrawals. This means that individuals can access funds relatively quickly when they face a qualifying emergency.

The act permits withdrawals for specific emergencies, which includes medical expenses, car repairs, home repairs or job loss. Since employees can self-attest to the emergency, this allows them to access the funds sooner with less paperwork. With a clear definition of emergency, the goal is to prevent misuse.

Perhaps even more important, SECURE 2.0 permits penalty-free withdrawals for emergencies. This is designed to encourage people to freely access their funds when they need to. At the same time, the Roth treatment ensures that contributions remain tax-free.

Let’s look at an example. Alex's ESA holds $2,000, earmarked for emergencies. One day, his car engine sputters, demanding immediate repair. Alex withdraws $1,500 from his ESA without incurring any penalties. He continues contributing to rebuild the fund.

Educational initiatives and financial literacy programs

SECURE 2.0 recognizes that creating ESAs is only half the battle; ensuring their effective utilization is equally crucial. Here’s how educational initiatives and financial literacy programs play a pivotal role:

  • Employee workshops: Employers can organize workshops to educate employees about ESAs, covering topics like ESA benefits, contribution strategies, and withdrawal guidelines. 
  • Online resources: The IRS and financial institutions can collaborate to create user-friendly online resources offering ESA calculators, FAQs, and case studies. 
  • In-person counseling: Face-to-face counseling sessions provide personalized guidance. This can be offered as part of the employee benefits package. 

Potential impact on financial institutions

The act presents both opportunities and challenges, as service providers must navigate the complexities of administering these enhanced accounts. SECURE 2.0 reshapes the financial landscape, impacting institutions in various ways:

Banks and Credit Unions

Financial institutions will manage ESAs, ensuring compliance with SECURE 2.0 provisions. They’ll handle contributions, withdrawals, and reporting.

In addition, banks and credit unions also become educators. They'll guide customers on ESA setup, investment options, and emergency fund management.

For banks themselves, they can market ESAs as part of their suite of services, potentially attracting new customers looking for holistic financial solutions.

Some challenges facing financial institutions include:

  • Administrative burden: Managing ESAs requires additional administrative efforts. Institutions must adapt systems and processes to accommodate these accounts.
  • Balancing act: Ensuring liquidity for emergency withdrawals while optimizing returns could pose a challenge to financial institutions. 

The act presents banks with additional opportunities, including the ability to deepen customer relationships and retain loyal clients. Financial institutions can also innovate by offering ESA-linked products like short-term CDs or low-risk investment options.

Timeline and implementation

SECURE 2.0’s ESA provisions are supposed to be implemented gradually:

Phase 1 (Immediate):

In January of 2024, the IRS provided detailed guidelines for employers and financial institutions on ESA setup, contributions, and reporting.

Employers should begin kicking off educational initiatives to inform employees about ESA options.

Phase 2 (Within 12 months):

Employers will begin offering ESAs as part of their benefits package. By this time, banks and credit unions will have adapted their systems to handle ESAs.

Phase 3 (Long-term):

The legislators will assess the implementation over time to ensure ESA effectiveness. Adjustments may be made based on real-world usage and feedback.

Shaping the future of emergency savings with SECURE 2.0

SECURE 2.0's ESA provisions are a significant leap forward in safeguarding Americans' financial health. As implementation of in-plan ESAs unfold, the act's impact on personal financial resilience and the broader financial industry could be profound. The legislative commitment to enhancing emergency savings promises to shape a more secure financial landscape for American workers in the coming years.

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