Before the retirement community shifted to a pretax 401(k) system in the 1980s, many companies offered a supplemental savings account (to be used for short-term emergencies) to complement the defined benefit (DB) plans of their employees. These supplemental savings accounts are nearly identical to what are known today as “sidecar accounts.” A sidecar account is essentially an additional savings account that is directly linked to an employee’s existing retirement account. Under the sidecar system, funds are set aside in a short-term savings account to be used in times of emergency, in an effort to prevent the harsh tax penalties associated with hardship withdrawals from an employee’s retirement plan. Under these accounts, money will be taken from an employee’s paycheck and set aside until certain “buffer” threshold is reached. After this “buffer” amount is reached, all future funds will go directly into the employee’s retirement account, just as they would normally. To ensure a consistent, adequate amount of emergency funds between the employee and his or her retirement account, the funds will be replenished each time a withdrawal is made.
Unlike with a DB account, a participant in a defined contribution (DC) plan has the option of using some or all of his/her funds for non-retirement related expenses, mainly in times of hardship. Because these emergency funds are more readily available, one in four DC plan participants will, at some point during his or her career, use some or all of his/her savings for non-retirement based needs. This is known as leakage. Because of the increasing amount of leakage from DC accounts, a survey was conducted by LIMA, which showed that 2/3 of workers in today’s market have some interest in setting up an automatic emergency savings account in addition to their retirement account. Furthermore, 89% of employers have shown interest in offering this product. There have been further studies conducted, revealing that if an account can be psychologically associated with future income and long-term assets, with less availability for withdrawal, account holders will be more successful in resisting the temptation of making a hardship withdrawal or cash out. They will thus be more likely to prevent retirement leakage. For all of these reasons, sidecar accounts are gaining ground as a viable solution to combat account leakage in today’s retirement community.
Although these accounts come with many benefits, there are many financial and regulatory concerns surrounding them. The first among these is: who should be responsible for delivering the account to customers? Due to their already-established payroll-based structure for retirement contributions, employers seem to be the most logical option for delivering these accounts. An employer would be able to package the 401(k) and sidecar accounts together and enroll workers in both simultaneously. As simple as it may sound, many employers may not be ready to take on the added responsibility and administrative costs associated with this new plan benefit.
So, if linking the two accounts is not a viable option for a company, there are still several other paths to choose from:
- Individually sold accounts: While still a viable option, this path is rarely chosen because linking the sidecar account with the normal retirement account can be complicated. Secondly, it can be difficult to integrate the second account with the employer’s payroll system so that savings are automatically deducted from paychecks, just like they would be with normal retirement deferral percentages.
- MyRA: This plan option was offered by the US Treasury Department and is set up in such a way that it could be split up into both long-term and sidecar accounts. Under this system employers could more easily fund their employees’ accounts through payroll deduction.
- Secure Choice: These retirement programs are state-led, but privately managed, and automatically enroll workers into their own IRA. Oregon, a Secure Choice state, has expressed interest in offering this form of sidecar account as an option to retirement savers. These programs use Roth IRAs, meaning they can more easily be treated as hybrid accounts in order to serve both short-and long-term needs. A downside to this is that transfers from an IRA can take up to three business days, so they may not be the best option in times of sudden hardship where funds would be needed immediately.
These options offer a lot of food for thought when it comes to helping employees protect their retirement savings. But, once an account structure has been chosen, the next step is to decide whether or not to offer automatic enrollment. If this turns out to be the best option, there are several ways to go about it, but each has its own set of serious disadvantages.[1] In an effort to combat these issues, one might look to active choice as the most viable option. Especially since research has shown that forcing employees into an active choice can greatly increase participation (even if not quite to the same levels achieved by automatic enrollment).
We believe the time is right to move from theoretical discussions about sidecar accounts into concrete action and real-world testing. Indeed, many researchers and policymakers are answering the call, actively exploring the possibility of pilot testing sidecar models. As they grapple with next steps, we hope that this analysis can help illuminate the key design choices they will face and the main considerations that should inform their decisions. We acknowledge that a sidecar account, if designed poorly, could be yet another complicated, parallel savings structure in the sea of 401(k)s, 403(b)s, IRAs, HSAs, and 529s. But if done well, we strongly believe that a sidecar account could improve the financial well-being and security of Americans in both the short and long term — an outcome that is good not only for families, but for the economy overall.
–The Aspen Institute: Financial Security Program
[1] Aspen Institute: Financial Security Program. Driving Retirement Innovation: Can Sidecar Accounts Meet Consumers’ Short and Long-Term Financial Needs? Pg. 7