What the Retirement System Would Be, if it Could Be
Tim Flacke, Co-Founder and Executive Director, Commonwealth
Imagine a world where, when you begin working you’re automatically enrolled in a retirement savings program. Regardless of the type of work you do, regardless of how young you are – assuming you’re at least 18. Imagine that your retirement account is set up with a sidecar savings account so that the first amounts you save get tucked away for an emergency – giving you peace of mind that you have a buffer against adversity. You’re now in a better position to commit to that longer term retirement savings. Of course you can always opt out of these easy pathways. But wow, what kind of world would that be?
Tim Flacke, Co-founder and CEO of Commonwealth, has been giving this a lot of thought alongside his incredible group of peers. Here’s a world he is watching begin to take shape.
Tim, we started talking about retirement and you jumped into the deep end of the pool. Tell us more.
Well, I’ve long felt that the retirement system can and should be playing more of a role in what is the pressing concern for most Americans in terms of their financial lives, which is much nearer term.
I think there's good reason to believe that if that system is more responsive to the near term, that it will also result in more people saving for the long term. There's mounting evidence that the majority of Americans, a huge percentage of us, really do live our financial lives worrying about tomorrow and next week. In that frame of mind, it's very, very hard to think about the long-term.
You mean, if we were better at emergency savings, we’d be in a better position to think about retirement savings.
Yes. We at Commonwealth think there's this enormous apparatus – the workplace retirement savings system - that has a strong policy foundation, wide recognition and acceptance by employers, a robust industry, really all the assets you want to have to come up with a systemic, comprehensive solution to a problem. I think it's very easy to make the case that employers who play a role in facilitating nearer term financial security (emergency savings) are likely to reap some benefits from workers who are less anxious, and who are appreciative.
This must seem especially timely right now.
It is. In fact, pre-COVID we had decided to do some nationally representative research on the state of financial insecurity in the country and, in particular, people's perceptions. Honestly, the genesis of this was the government shutdown, which seems like forever ago. In early 2019, suddenly we're reading news stories about the fact that there are hundreds of thousands of pretty well-paid federal workers who are literally a paycheck or two away from real trouble.
Being close to this, we weren't as surprised maybe as the media was, but the stories we read were, oh wow! lo and behold there's all these people who are concerned about really near-term financial issues. So we organized nationally representative research, Perceptions of Financial Security in America. One of the headlines was that ‘81% of people said' -- 81% pre-COVID -- said financial insecurity is a major problem. Even more interesting in some ways is that the majority of folks pointed to factors beyond their individual control. The thing we hear so often is, if people just had more financial education, if they made different spending choices, it would all work out.
So are you saying that’s not true?
It's pretty clear from what we've found that that's not most people's experience. Just 30% of respondents linked financial insecurity mostly or exclusively to personal choices – behaviors like overspending or poor work ethic – while an overwhelming 70% told us they believe financial insecurity is related to external factors. And, no surprise, there's a racial dimension to it too. You are 29% more likely to point to external factors if you're Black or Latinx, and 27% more likely if female. So people's experience affects their perceptions of the causes, and their sense of where the solution should come from.
Then you get to, well, who should play a role in trying to address this? Very clearly people say employers (65% of our respondents) and the financial services industry (58%) and government (over half). Now that covers a lot of ground, but I think it's relevant to this conversation.
Employers, the government and financial services would be a trifecta. What are you seeing?
Interestingly, two years ago, we were just hearing about Prudential having waded into the space of “sidecar savings”, which you’ll also hear called “retirement adjacent” savings. Over time, we’ve started to see more of this. Just a few weeks ago my colleague Nick Maynard conducted a webinar with leaders from John Hancock, MassMutual, Prudential and Voya. As that webinar demonstrates, there are now at least three or four products in market from household name providers that focus on employer-based emergency savings. This is a really important shift that's happened fairly recently.
And I believe it’s the result, in part, of concerted effort. As you know, Commonwealth is one of three organizations helping bring to life BlackRock’s Emergency Savings Initiative, an ambitious, multi-year effort to enable LMI households to access and use proven emergency savings tools. Integrating emergency savings into the workplace and into the retirement system has been a key focus of the Initiative – since some savings cushion is the foundation of financial security, with benefits for workers and their employer alike - and it’s starting to bear fruit. As one example, under the Initiative we’re working with UPS to bring emergency savings to tens of thousands of their associates, operating in tandem with their 401(k) plan.
This is important progress. I have heard senior retirement industry people acknowledge that they haven't always had the best answer when employers come knocking and ask, what can you do for my regular working people? Sometimes the easy answer has been financial wellness platforms designed to give advice to pretty affluent employees. I think there's now a catching up going on. The industry is saying, well, this wasn't a fluke, we're hearing from a lot of different employers that they want broader-based solutions that make a difference in household financial wellness for regular workers. We need to have a better answer. I think this is where some of the emergency savings innovation is coming from.
Is more resilient retirement savings somehow linked to having emergency savings?
When considering enrolling in a retirement plan, we know that people will always ask themselves whether they want to put their savings in a long-term vehicle when they have short term needs.
Now if that plan includes an emergency savings offer, that calculus may be a little bit different because the whole framing is you're setting it aside for whenever you need it. So perhaps it will lead to even stronger participation, first in the emergency savings accounts, and then into retirement savings accounts over time.
Options for short term savings in a retirement system have also evolved. We now can more confidently say there's a) in-plan after-tax emergency savings (Prudential’s sidecar would be an example), and b) out-of-plan emergency savings (for example, MassMutual partners with Millennium Trust to offer this, John Hancock has an app called Twine that enables savings out of plan), and there are associated pros and cons to each of those approaches. And we can point to different industry players investigating how to solve the emergency savings challenge, and even some that are testing options.
There’s another model that’s a bit of a hybrid, as we see in the State Auto-IRA programs.
Yes. My sense is that the state facilitated retirement savings programs are ahead of the curve in some ways. Here we see the overlap between short term and long term, right. Isn't it in Oregon and California that the first thousand dollars saved goes into a liquid vehicle?
I think that both could be instructive to the rest of the industry, and the rest of the ecosystem. And there may be an opportunity to keep planting that seed, as we see more states continue to pass legislation to go down this path.
I would expect that savers those programs cover are even more likely to be concerned about the near term and the short term. So it makes sense for those systems to have this same concept in mind, what's our role in creating structures that help address the short term needs of our long-term savers?
We also wonder about the potential of 529 plans to use this sort of idea. It’s the same bridge -- if you want to get lower income, more vulnerable families taking advantage of those systems for saving for education, try speaking to their near term needs and genuinely plug a gap in the marketplace. We still hear from lots of families that say, there just isn't a place for me to save 50 bucks one month and draw it down the next. That's not really an easy thing to find a good solution for. So there's a similar argument to be made here in the 529 space.
Let’s talk about some of the experimentation you’re involved in. What do the accounts look like? What are you learning?
Let’s talk about the in-plan options first. Let’s say you are an employer with an in-plan after tax savings option. Even though it’s originally designed as part of a retirement plan, the emphasis can be shifted so that the account is understood to be a tool for short term savings needs.
This can be useful, but we’re also seeing that a potential drawback with this approach is that it doesn't necessarily provide very fast access to the funds. We know that to function as true emergency savings, that there's an incredible value placed on really, really fast access to funds. Most plans that are set up with after tax provisions didn't have that in mind. And they may not have a mechanism to put those funds as fast as possible into somebody's hands or their checking account. And of course there are still tax issues to the extent that you have to take a proportional share of earnings that haven't been taxed.
That makes sense.
So we are really interested in exploring out-of-plan emergency savings, which could provide dedicated emergency savings with easy access. Here’s one form of what that looks like. It starts with a retirement provider striking a relationship with a third party that serves as a depository. The depository could be a bank, credit union, a fintech or even a cash management account at a broker or mutual fund company. The retirement provider facilitates the collection of contributions as part of their regular support activity, passing them to that third party. That may seem like a relatively mundane goal, but what we have heard is that for busy employers having a retirement plan provider who is a known entity present this sort of turnkey solution makes it a lot easier to implement.
And then from the worker's perspective, there's an opportunity to receive an integrated messaging and user experience for emergency and retirement savings, so that it's not two separate things. Savers come to one online destination, one employee orientation meeting, and hear about both issues, and that their employer can facilitate participation in both options through one experience. We see those things as really powerful and we're excited about further development of that approach.
So how close are we here Tim? It sounds like providers and employers together are working to figure out the logistics and to create something that could be generally available in the market.
Yes, I think that's a fair characterization. For what it's worth, we have been struck by how rapidly student loan repayment has spread throughout the retirement industry as a concept. We know that's been fueled in part by an IRS private letter ruling, but it's an interesting thing to point to because it has been pretty fast. In the last five years we’ve gone from nobody talking about that, to almost everybody having at least something to say about it. So we take a bit of inspiration from that. We think it's a combination of raising the profile of the emergency savings issue and answering the question, well, how does one really do this? Making it a real actionable choice for employers. And so there's similar evolution on this issue.
Let’s shift gears for a moment – what did you learn about the financial impact of COVID-19 on low and middle income families?
As you know, we partnered with DCIIA and went out and talked to participants in plans with annual incomes between 25 and 75k. The first question we were interested in was whether there was any relationship between those households or employees that have liquid savings and how they behaved in their qualified plan.
Here’s what we found: having little or no liquid savings increases the likelihood that participants will take what we call “negative action” in their retirement account. This means, they are more likely to take a hardship withdrawal, pause contributing, or reduce their contributions into their retirement accounts.
So that's an intuition that would make sense. But to see evidence of it we thought was important. The research was conducted from April 30 to May 9. At that point, relatively few low- to moderate-income participants had actually tapped into their accounts. Only 5% had withdrawn money from their retirement accounts. Another 7% said they planned to.
We wondered, if they’re not using retirement savings to make ends meet, what are people doing to respond to their financial experience in the pandemic? And the answer is, it appears the first action that most LMI (lower and middle income) participants were taking was to reduce their expenses. 70% told us they had reduced their expenses compared to the 5% who had already taken a withdrawal from their account.
We’re now further into the economic effects of COVID and we don’t yet know how this may have changed. We did see some evidence that plan participants were using their credit cards as a source of emergency funding, basically managing through the shortfall.
We know you’re still hard at work.
Yes, now we’re out there talking to eligible employees who are not participating in their employer’s plans to understand how their experience might differ from those who are participating. And we’re working with DCIIA and the SPARK Institute to further understand the perspectives and experience of recordkeepers.
The state Auto-IRA programs early on saw a spike in withdrawals. Then that seems to have settled down. You would think as time goes on that things would get tougher.
Since COVID hit, we've begun following the financial lives of 50 LMI households in great detail, and in fact we just released a brief on what we’re learning. In short, households are experiencing a “tsunami” of volatility, which makes sense when you think about the way people have received relief here in the US. A lot of people lost their jobs. For many of those folks, there was a delay until the CARES Act payments arrived. Then there was a spike of those CARES payments. Then there was an application for unemployment, which took a long time. Then when unemployment was awarded, there was some back pay, and there's the $600 supplement. Now we know that has ended. All of this is an enormous emotional and time burden on people, and I wonder if it just encourages us to live in the moment, wait for the next development. A side effect may be that people wait before turning to less accessible assets, like retirement savings.
Looking forward, what we are thinking and concerned about is this: eventually individuals’ unemployment benefits will expire. And then the real kicker is that many of these households are used to seeing tax season as a source of income in the form of a large federal refund. But in the spring of 2021, many families who received unemployment will suddenly be faced with a large amount of their 2020 income that was taxable but did not necessarily have taxes withheld. And now with the payroll tax deferral, that situation is likely to be worse. These families are going to walk into tax appointments thinking they’ll get a little financial relief, a refund, a moment to catch up. And they're probably going to be handed not just no refund, but a substantial tax bill.
Let’s talk about emergency savings during a pandemic. Do you think that it makes sense to pursue ideas like this, even though many people are under pressure?
It's a great question. And we wondered a lot about that in the early stages of the pandemic. What we've seen so far is similar to what we have seen in prior recessions. It’s counter-intuitive, but household personal savings rates have climbed quickly and dramatically. And we have even seen evidence that extends down the income spectrum quite far- though of course not for someone who has lost all their household income. But, knock on wood, the majority of us are still employed. And I think people just have a much more visceral sense that we need to be preparing better for the disaster that has already befallen us, and we don't know how long it will last.
There's also the fact that for some people, some regular expenses have fallen as we've been sheltering in place. JP Morgan Chase Institute has some good data on that and the correlation between reduction in spending and other behaviors. I think what you've seen is a dramatic increase in the desire to save. And in some cases, somewhat paradoxically, perhaps a little more capacity to save, and those things are driving interest and action around savings. From where we sit, it's actually a very sensible time for employers and record keepers to be addressing this need – workers and customers want to build emergency savings right now.
In fact, there's a case to be made that the quicker one can act, the more there's a chance to be relevant to people in this period of economic crisis.
Tim, we've had a wide ranging conversation, please take a moment to tell us more about Commonwealth and your focus.
Yes! Commonwealth is a mission driven organization focused on the challenge of widespread financial insecurity. Our belief is that ultimately what makes the strongest difference for households is being able to build some wealth, and stronger household balance sheets. So that's our north star - to make that possible for many, many more financially vulnerable people. Against that challenge, what we bring is innovation -- a willingness to see challenges that sometimes get overlooked and try different approaches that we think can work for working households, those with low and moderate incomes.
We're in this very special position of being able to take philanthropic capital and invest it to develop solutions that can make financial security and opportunity possible. Our theory of change is that the way we get to scalable, sustainable outcomes is to influence market actors, and sometimes policy makers, to embrace ideas that work. And one of the ways we see ourselves is incubating those ideas and building the evidence base and laying the pathway so that it is more possible for other actors to take them up and run with them.
Terrific. Thank you so much for joining us Tim! Folks, connect with Tim Flacke on LinkedIn and by email. You can also follow the work of Commonwealth on social and engage with them on these channels: Twitter, LinkedIn, and Facebook.
This piece was featured in the August 13, 2020 edition of Retirement Security Matters. For more fresh thinking on retirement savings innovation, check out the newsletter here.
