“Every object will remain at rest unless compelled to change its state by the action of an external force.”

– Isaac Newton

“Every non-saver will remain not saving unless it is made, like, super easy to save.”

– Geoffrey Sanzenbacher

Let me tell you a story. In the past, I was a retirement researcher. When you are a retirement researcher, people ask you for advice. That advice has two simple parts. First, start saving early. Second, keep working as long as possible. The “start saving early” part is key. For example, at a real interest rate of 4 percent, a dollar saved at age 25 will be worth $4.80 at 65. But, if you start at age 35, that same dollar will only be worth $3.24 at age 65 — a 33 percent decrease. Compound interest is the bee’s knees.

I knew this fact when I started my job as a retirement researcher. Yet, it still took me two full months to sign up for Boston College’s generous 401(k). Why? Because the Human Resources office was a mile away from my office on campus. And, I started working at BC in March. Have you ever been to Boston in March? It ain’t walking weather.

Luckily, academics and financial service providers have found a way around the tendency of non-savers to remain non-savers — automatic enrollment. Automatic enrollment in a 401(k) is exactly what it sounds like. The default is that you begin contributing to the account as soon as you become eligible, but you can opt-out if you want to. The research makes it clear that automatic enrollment makes a huge difference in participation. Yet, automatic enrollment as a feature isn’t applied to all kinds of savings — just retirement. And, that’s a problem, because people don’t just need to save for retirement. They need emergency savings too.

Many Americans Lack Emergency Savings

Every three years, the Financial Industry Regulatory Authority puts out its “Financial Capability Survey.” The survey asks people a variety of questions about their financial situations and about their knowledge of issues related to personal finance. Here is an example of a personal finance question, see how you do:

If you said at least 2 years but less than 5 years, good job! The answer is about 3.5 years, which you can find using the “Rule of 70.” If you divide 70 by the interest rate, it tells you how long it takes something to double.

As far as information on people’s financial situations, two questions are relevant for the topic of emergency savings. One question asks people if they have: “set aside emergency or rainy day funds that would cover your expenses for 3 months, in case of sickness, job loss, economic downturn, or other emergencies?” The second question asks how confident a person is they can come up with $2,000 if needed. The results of these questions are provided below for individuals ages 25-54.

Figure. Share of Individuals Ages 25-54 with Emergency Savings

The figure shows that less than half of households in the bottom two thirds of the survey’s income distribution have a rainy day fund. And, only half are confident they can come up with $2,000. Things get much better as one moves up the income distribution into the top third of surveyed households — those with $75,000 or more in income.

So, how do we increase these numbers for all households, but especially those with less income? The answer is: make it easier. Enter the recently passed spending bill.

Secure 2.0 and Automatic Enrollment Savings

In 2019, then President Trump signed into law a bill nicknamed “The Secure Act.” In my opinion, this law was a complete dud. Usually, the first bullet of the law’s summary said something like: “[the law increased] the required minimum distribution age increases to 72, up from 70 1/2.” Which is a really long way of saying that the law did nothing super important. As my old boss Alicia Munnell put it, succinctly (as always): “I don’t really think [its] going to move the needle much at all.”

Luckily for all of us, this law had a sequel, Secure 2.0. And, it was rolled into the spending bill just passed by Congress and signed by President Biden. One of the bill’s most notable provisions is that it requires new 401(k) plans to incorporate automatic enrollment by 2025 (too late for me!). This provision alone makes the law a huge improvement over the existing system.

But, from the point of view of this post, its most important feature is that the act creates a new “side-car” for 401(k) accounts. In the future, these accounts can add an emergency savings account. These accounts would accept up to $2,500 a year in post-tax contributions, and employers would have the opportunity to match.

The “post-tax” part is important. Right now, most people contribute to their retirement accounts pre-tax. So, workers don’t have to pay taxes on the earnings they put away for retirement in the year they earned the money. Instead, they pay the taxes later on, when they take the money out. In exchange for delaying the payment of taxes, the government penalizes workers if they take this money out before retirement. Which makes the traditional 401(k) a pretty bad vehicle for emergency savings. By creating a separate account within the 401(k) system that has a tax treatment more amenable to emergency savings, Secure 2.0 actually does something. It leverages a system that has proven itself to be effective at getting people to save for retirement to also begin saving for emergencies. Nice.

But…Don’t Get Too Excited!

That was pleasant. I don’t know how you felt reading it, but I enjoyed writing that section. I got to take a pot shot at Secure 1.0, and spread some good cheer about a potentially useful change to policy in Secure 2.0. But, I hate pleasant.

Here’s the problem with Secure 2.0. The bill still doesn’t address the biggest problem with our retirement system: coverage. Today, somewhere between a third and a half of workers don’t have access to 401(k)s at all. These individuals will not have access to the emergency savings vehicles made possible by Secure 2.0. And, you can guess what part of the income distribution these individuals come from: the bottom part. According to that same FINRA survey, less than half of people with income under $75,000 have access to a employer-based retirement plan within their household. That number is over 80 percent for households with over $75,000 in income. So, this law won’t reach those that need the emergency savings the most.

Which gets me back to a major problem I have with our nation’s benefits system: it’s employer based. I really can’t stress how stupid this feature of our system is despite how engrained it is in all of our minds. Do you live in an employer-provided house?

I would love to see the U.S. move away from employer-based benefits. In the 401(k) context, it seems entirely realistic to set up accounts tied to each individual, and managed by some third party. People could even pick between the current providers like Fidelity, Vanguard, Empower, etc. Employers could contribute to these accounts as they do now, and contributions could be pre- or post-tax just as they are now. In fact, we already have a system where employers contribute to individual-based accounts. You know…your freakin’ checking account! Last time I checked, my checking account wasn’t tied to BC. Why not do this for 401(k)s?

Anyway, for now I suppose we will have to settle for the victory of Secure 2.0. The employer-based system is here to stay for now. You know, that inertia thing is a real pill.

P.S. If you liked reading this post, don’t forget that I wrote a book. It’s chalk full of awesome if you want to buy it.