New Bill Would Help Employees Build Emergency Savings

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KEY POINTS

  • The bill's Pension-Linked Emergency Fund would allow taxable deferrals directly from your paycheck.
  • An employer match would be allowed, but contributions would not be able to exceed $2,500 per year.
  • Distributions would be less restrictive than qualified retirement plans.

Boosting your rainy day fund might get a whole lot easier.

The Emergency Savings Act of 2022 was introduced in May by Senators Cory Booker (D-NJ) and Todd Young (R-IN). It establishes so-called Pension-Linked Emergency Funds, which will help employees save for emergencies through payroll deductions and help improve their personal finances.

What is a Pension-Linked Emergency Fund?

What's in a name? Something misleading when it comes to Pension-Linked Emergency Funds. While the emergency funds are tied to employer retirement plans, they aren't limited to pension plans. Instead, a Pension-Linked Emergency Fund may be linked to a defined contribution plan, such as a 401(k).

At its core, a Pension-Linked Emergency Fund is an emergency fund that is managed like an employer-sponsored retirement plan. Funding of the emergency fund is similar to funding a 401(k), with deferred contributions automatically being deducted from one's paycheck. Unlike a 401(k) contribution, an emergency fund contribution would not include any tax benefits, meaning that any contributions are fully taxable as ordinary income. The bill contains a provision to allow automatic enrollment of up to 3% of compensation.

Once deferrals are made, they would be managed by retirement plan administrators. Because emergency funds are supposed to weather economic downturns, the legislation provides that contributions can be held in cash, interest-bearing accounts, or other principal-preserving investment products.

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What about an employer match?

Employers looking to get involved would be able to make matching contributions, according to the bill's text. The matching contributions provision would work similarly to 401(k) matching, minus the tax advantages.

However, the bill also provides a limit on how much can be saved by both employer and employee. The combined contributions to the account cannot exceed $2,500, indexed annually for inflation. A $2,500 emergency fund pales in comparison to the expert-recommended rule of thumb of three to six months of expenses. 

Use our emergency fund calculator to see how your savings stack up.

How are distributions treated?

An emergency fund is only as good as it is accessible. And according to the legislation's text, a Pension-Linked Emergency Fund will be much easier to access than a 401(k). The bill allows for withdrawals at the discretion of the participant. However, the bill requires that plan sponsors allow withdrawals at least once per month. Additionally, distributions must be made within one week of a withdrawal request.

What's next for the bill?

Introduced to the Senate in May, the bill was read twice before the Senate and referred to the Committee on Finance. The bipartisan sponsorship of the bill bodes well for a divided Congress. It is unclear whether the bill will pass the Senate in its current form, or when it will be voted on. For now, the bill has a long way to go before becoming a law, including passing the Senate, the House, and being signed by the president.

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