The latest Prosperity Now Scorecard highlights the fragile financial situation many American families face. One in five households experience significant income fluctuations, and 44% were not able to set aside any money to cover emergencies over the last 12 months. It’s not surprising, then, that many of these households are forced to tap long-term assets like retirement accounts to deal with income volatility and other short-term financial hardships. According to a 2013 report, one in four people with a defined contribution retirement plan will use all or some of their savings for nonretirement needs such as paying a bill, buying a home, dealing with a medical emergency, or sending a child to college.
So how can we help families cope with financial shocks and volatility while protecting their retirement accounts from being depleted prematurely? As we described in a recent brief, one exciting new idea to solve these interrelated problems is linking a short-term savings, or “sidecar,” account to a traditional retirement account.
The idea is simple: Workers would fund a short-term savings account that could be used for emergencies, and once a sufficient savings buffer was built up, additional contributions would automatically be diverted to a traditional, less liquid retirement account. To ensure a constant savings buffer, the short-term account would be automatically replenished as necessary. The hope is that by formalizing the dual role the retirement system currently plays, savers would be in a better position to distinguish between what is available now and what is locked away for retirement. This would allow them to meet both short- and long-term financial goals more easily.
Possible Sidecar Delivery Channels
Sidecar accounts could take several forms. Key design questions, which are explored in detail in the brief, include:
- Which institution – employers, governments, financial institutions, or some sort of hybrid public-private solution – should deliver the sidecar account to consumers?
- How should the account be structured for fiduciary liability and tax purposes?
- Should enrollees be automatically enrolled in the sidecar account, and, if yes, how can that be done given current legal constraints?
- How large of a balance should be allowed to accumulate in the sidecar account before future contributions begin flowing to the traditional retirement account? Or, to ensure regular and consistent stock purchases, should they be funded simultaneously?
- What withdrawal restrictions, if any, should be placed on the sidecar and retirement accounts?
- What financial incentives, if any, should savers (or their employers) receive for funding the sidecar account?
Though we don’t yet know the answers to these questions, 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 our 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.