For better retirement outcomes, improve emergency savings: Prudential's Phil Waldeck

The strides that defined contribution plans have made in the past decade are far from lost on Phil Waldeck.

But the need to improve the overall financial security of plan participants is as obvious as the to-date improvements themselves, thinks Waldeck, who was named president and CEO of Prudential Retirement last year.

“Retirement plans have made real progress,” Waldeck told BenefitsPRO, noting the role automatic features and qualified default investment alternatives have played since passage of the Pension Protection Act in 2006.

“But plan leakage is an area of real weakness,” he said.

Over the years, data on the impact of plan leakage has varied substantially.

In 2015, nearly 90 percent of all defined contribution plans permitted loans, and 80 percent permitted hardship loans, according to the Plan Sponsor Council of America.

Most loans are made at a rate of 1 percent above the prime rate — the average rate for all plans was 4.8 percent, according to PSCA. The majority of plans allow only one outstanding loan, but more than 36 percent allow two. Three-quarters of sponsors require a minimum loan of $1,000.

Just how much of those loans actually contribute to plan leakage has been the subject of debate among some of industry’s most qualified minds. In 2014, the Pension Research Council published a working paper–authored by four prominent retirement economists– that estimated $6 billion in annual 401(k) loan defaults, considerably more than previous estimates from the Government Accountability Office.

Suboptimal outcomes

IRS data shows that 90 percent of plan loans are repaid in full.

But it is data on emergency savings rates outside of retirement plans that may put plan leakage into better context.

Bankrate.com published a survey this year showing a quarter of respondents have nothing in emergency savings. Another 22 percent only have enough to cover less than three months of household expenses—retirement strategists commonly recommend a six-month emergency savings cushion. Prudential and other service providers have generated data showing millions of Americans are unable to cover as little as several hundred dollars in unexpected expenses.

“We know the existing system is creating suboptimal outcomes because so many participants can’t weather a $500 hit to their finances,” said Waldeck. “Too many people get derailed way too easily by financial challenges—they are vulnerable,” he said.

The correlation between short-term emergency savings shortfalls and retirement security is clear, says Waldeck. “More short-term savings drives better retirement outcomes.”

Last week, Waldeck and his team at Prudential Retirement rolled out a new plan feature intended to bridge plan participants’ need to save for unexpected near-term financial shocks within existing 401(k) plans.

Read: As House considers Universal Savings Accounts, Prudential isn’t waiting

Under the feature, sponsors can implement a savings structure allowing after-tax participant contributions to a supplementary savings account within their existing retirement plan. Contributions would accrue to give participants a savings cushion they could tap in the event of an emergency.

Withdrawals from the emergency savings source within plans would not be treated as a plan loan. But they would be treated as an in-service withdrawal, meaning any investment earnings on the after-tax contributions would be subject to a 10 percent early withdrawal liability, per existing IRS regulations.

The theory behind the emergency savings feature is to tap the efficiencies of payroll deductions and automatic features in existing plans, and pair those with existing tax law that allows for after-tax contributions beyond the statutory limits on pre-tax contributions, explained Waldeck.

“Participants’ financial lives are more complex than just their defined contribution plans,” he said. “We’ve learned from automatic enrollment that the workplace is a really effective setting for impacting retirement savings. The question was how do we use existing retirement platforms to affect positive change to protect against the leakage dynamic and create a protective barrier.”

Participants would see a third line on their account statements, documenting after-tax savings to the emergency bucket. How much should be saved for emergency needs would be dependent on individual participants’ circumstances.

Ideally, participants would not have to reduce existing contributions to the pure retirement savings bucket to fund emergency savings. But even if a participant would have to divert some deferrals to the emergency savings bucket, they should, says Waldeck, so long as they are not leaving the employer match on the table.

“People should have an emergency savings buffer first, but failing to get the employer match would be a big miss,” he said.

A unique feature

Waldeck says Prudential’s new feature is unique in industry in the way it is using the existing defined contribution framework to address leakage via emergency savings contributions.

The feature’s rollout comes as both chambers of Congress are considering comprehensive retirement and savings reforms.

Under one bill recently introduced by Sen. Heidi Heitkamp, D-ND, participants in 401(k) plans could defer up to $10,000 in short-term savings accounts. That policy makers are focused on delivering both retirement and general savings incentives is clearly a positive development, said Waldeck.

Were Heitkamp’s law—which has two Republican co-sponsors—to pass, the effort behind Prudential’s new savings feature would not be in vain, thinks Waldeck. “We want a lot of company in this effort.”

But politics is politics. The legislative options on the table will be “challenging,” despite the political comity common to retirement policy, notes Waldeck. Which is why Prudential is not waiting to address emergency savings shortfalls.

“The tougher question is how do we achieve scale with this solution. If legislation can help us do that, that’s great,” he said.

If the retirement and savings proposals on the table sputter in the near term, plan providers and sponsors will not be without options to address emergency saving shortfalls, and their ultimate drain on retirement security.

“Existing law gives the ability to make both pre and after-tax contributions. We felt we could make a big impact on leakage with the tools we have today,” said Waldeck.