What, you ask, is a sidecar account? The short version is that it’s an attempt to use the existing mechanism of a 401(k) account to encourage greater levels of emergency savings. This is in response to studies showing that significant numbers of Americans report not having any sort of emergency cash (see my September article); other studies show that this is not limited to the poor whose finances prevent this, but significant numbers of even the middle- and upper-middle-class live paycheck to paycheck (even 25% of American families earning more than $150,000 per year, according to a study cited in Investopedia), a group that might be helped by providing opportunities to save more automatically.
As MarketWatch reported today, some employers are trying to help their employees increase their rainy-day savings, in part in order to reduce their reliance on 401(k) loans. The most straightforward option is to simply provide a match for contributions employees make to savings accounts at banks or credit unions, either with a direct deposit of a portion of their paycheck, or through a regular auto-transfer of a specified sum from their checking account.
The sidecar account, in contrast, is linked to an employee’s 401(k) account. Here’s MarketWatch’s description:
In a sidecar account, an employee uses after-tax money (as opposed to the pretax money allocated to a retirement plan). Once the after-tax cash builds up to an employee’s comfort level, future payroll deductions can then be directed into his or her pre-tax retirement savings. If the emergency-savings after-tax balance drops below its intended target due to withdrawals, the employee can rebuild the balance up to his or her target with future after-tax contributions. . . .
Sidecars are funded with after-tax money because the Employee Retirement Income Security Act of 1974 law, known as ERISA, doesn’t specifically allow pretax saving through employers; investment earnings are taxed when withdrawn. Current law doesn’t allow auto-enrollment for sidecar accounts, either. . . .
A bipartisan Senate bill, the Strengthening Financial Security Through Short-Term Savings Accounts Act of 2018, aims to rectify those drawbacks, letting employers automatically enroll workers in easily accessible stand-alone accounts or sidecar accounts. The bill would also see the Treasury Department create a pilot program that offers incentives to employers to set up short-term savings accounts. Companies could put $400 into each employee’s account.
As the Aspen Institute reports, this bill was introduced in July by a bipartisan group of senators. The text of the bill is brief, specifying that such plans are henceforth permitted under ERISA provisions, with account balances limited to $10,000 (with future inflation-adjusting), and with the employer bearing fiduciary responsibilities, including the obligation to ensure reasonable fees for the accounts.
This bill has not passed.
Separately, however, the House has passed its version of such a bill, the Family Savings Act of 2018. This bill has a number of components (a brief description is at Plan Sponsor), but the one of relevance here initiates Universal Savings Accounts, Roth IRA-like accounts with annual contributions limited to $2,500, which, in broad outlines, are a variant on the sidecar accounts.
Sounds good, right?
But here’s what Forbes contributor Howard Gleckman has to say:
The idea begs the question: Why is Congress creating a new tax-preferred savings vehicle? We already have IRAs and 401(k)s, with both traditional and Roth versions of each. We have other retirement savings vehicles such as Keogh plans, SEPs, SIMPLEs, and individual 401(k)s. There are tax-advantaged savings for health care (Health Savings Accounts), college education (529 accounts) and support for young people with disabilities (ABLE accounts). . . .
We also know that high-income households are by far the biggest beneficiaries of tax-free savings. TPC’s analysis of retirement accounts finds that the highest-income 20 percent of households (those making $153,000 or more) get nearly all the tax benefit of those savings accounts. Those making between $320,000 and $755,000 (the 95th to the 99th percentiles) get almost half. . . .
And those with low and moderate incomes, who don’t take full advantage of the accounts they have already? Some won’t have the disposable income they need to create yet another account. Others may be tempted to shift money into a USA account because the withdrawal rules would be much more flexible than a 401(k). But for some that would be a mistake. If, for example, you work for a company that matches your 401(k) contribution and you have not maximized the match, diverting cash to a USA account could be an especially poor choice. . . .
[T]hese accounts are unlikely to enhance savings for many families.
So who’s right? Everyone is, to a certain extent. Low-income families who simply cannot save, given their income and expense levels, have an entirely different set of needs than those with higher income who fail to save because they lack financial education and/or temperament to save independently, but might succeed if the right “nudges” were in place. Yet as soon as pretax “nudges” are implemented, they will benefit both those who truly needed those incentives to put them onto a savings pathway, as well as those who were already saving, even without incentives. And having the option of a flexible-withdrawal savings account that provides the same pretax benefits as a 401(k) may increase savings levels for those who would have otherwise rejected a 401(k) because of its lack of flexibility, or who are using their 401(k) as a de facto emergency savings account anyway, but at a cost of reducing retirement savings for at least some families — though I don’t believe loss of 401(k) matches is a significant concern, since there’s a good chance that employers would match these accounts in the same manner. (Note that in my above-linked article I speculated that the mismatch between survey responses about unexpected expenses and rainy-day accounts could be explainable if a significant portion of Americans viewed their 401(k) as simultaneously a rainy-day account.)
Is this solvable by reengineering both 401(k) and savings plans in general, to provide flat dollar amount matches rather than tax advantages? A Saver’s Credit already exists, providing as much as a 50% match up to $2,000, depending on income, for low- and moderate-income taxpayers. In principle this could be ramped up and made payable for short-term savings, though in the latter case, it would be easy to game the system by signing up for auto-contributions but then withdrawing the cash just as routinely. But, again, if the objective is to nudge paycheck-to-paycheck middle-class and upper-middle-class workers into saving, doling out this sort of cash doesn’t make sense, either.
And perhaps the answer is simply to say that the lack of savings by those who, based on their income levels, are perfectly able to do so, is not the government’s problem to solve. But as long as the government is taking this on, then, like it or not, there’s an inevitable trade-off, rather than an easy answer.
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