The Tax Man Cometh, And He Brings Thoughts About Auto-Enrolling Savings Accounts

One third of all Americans rely on their tax return to make ends meet according to a new study from online consumer finance company Credit Karma. More than one third of respondents said they plan to use their refunds to build their savings accounts and 31% plan to allocate the money to pay down debt.
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Plan sponsors contemplating changes to their auto-enrollment functions may want to pay attention to the rising number of folks using their tax returns as savings. Are Americans using their tax return as a default savings account? The average tax return was $3000, somewhat less than the average amount of savings at $5000 according to some sources.  Auto-enrollment in savings for employees without an emergency account is a newer feature of some employee benefits dashboards and is not without criticism. Some policy analysts have deemed auto-enrollment in savings plans to be a bit too “big brother” or directive. Yet, every financial advisor and consumer finance expert lists emergency accounts as the top priority for consumers.
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For plan sponsors, the choice to add a savings account to their benefits line up may be difficult. Some may ask if the regulatory changes to how participants can withdraw funds from their 401(k)s would make this kind of savings account unnecessary. New regulations, including the Secure 2.0 Act, have changed hardship rules expanding the concept of hardship. Surveys show that plan sponsors have been making changes to their plans to provide more flexibility to plan participants and to incorporate the new changes brought by Secure 2.0. For those sponsors who were initially not thinking about broadening their hardship withdrawal provisions, this new information about the reliance on tax returns may be food for thought on that option.^[1]
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While there isn’t information about why Americans opt for using their tax return as an additional savings option, we think the behavioral finance behind savings habits points to a few points plan sponsors may want to consider. This tax return as a savings account survey result raises two questions: first, can plan sponsors make the action of saving easier and second how can plan sponsors help employees create a habit of savings. Studies in behavioral finance point to simplification for both questions.
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It’s highly likely that most Americans are using their tax returns for emergency purposes because it doesn’t require active choices. In other words, it’s a no brainer. Having to repeatedly choose to save from each paycheck requires an action, even though it is small. As we’ve brought up before according to the AARP more than half of American households lack an emergency savings account. We also know that engaging with a benefits system, whether it is a healthcare savings account, 401(k) or savings account, that requires multiple dashboards or internet only interaction may prevent employees from regularly using it. It is easier to form habits from small, simple actions. Plan sponsors that want to add savings accounts as a benefit may be considering adding auto-enrollment because of its simplicity. In fact, plan sponsors overwhelmingly agreed that autoenrollment for retirement savings was positive. “[A] whopping 87% of employers agreed that automated features have increased plan participation among their employees.”^[2] Many sponsors have also increased the amount of pay set aside in an auto-enrollment feature from 3% to 5% over the last five years.^[3]
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Plan sponsors may also want to consider how they message auto-enrollment. One option is how they word their opt out options. Behavioral finance suggests using enhanced active choice messaging. Active choice is when there is no default decision and makers are presented with a choice, while enhanced active choice highlights losses of the less positive alternative. To oversimplify, enhanced active choice presents a “good” and a “bad” option, and forces users to choose.
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The tax return as savings makes a compelling case for auto-enrolling employees in emergency accounts. But there are several points of caution on the road to auto-enrollment for savings accounts. Sponsors may want to discuss seasonal or part-time employees with their legal and tax advisors, as inclusion of these employees may create concerns around plan testing.^[4] Additionally, regulations around electronic transfer of employees’ funds may have given sponsors concern in the past. Some changes to regulations in that area may provide sponsors with more flexibility.^[5] A report from the Aspen Institute provides additional suggestions for policy concerns. Sponsors may want to consider reviewing that report, titled Moving From Experimentation to the Mainstream: Policy Options to Automate Workplace Emergency Savings with their vendors and advisors.
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There are two options some plan sponsors have been deploying, according to the Principal study. One is to auto-enroll plan participants into an emergency savings account if a participant requests a loan from their retirement account. The other is to auto-enroll plan participants into an emergency savings fund before those participants can begin contributing to their retirement plan. ^[6]

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^[1] https://www.bcgbenefits.com/blog/hardship-and-leakage

^[2] https://www.bcgbenefits.com/blog/new-plan-designs

^[3] https://www.bcgbenefits.com/blog/401k-participation-rise

^[4] https://www.bcgbenefits.com/blog/auto-enrolling-seasonal-workers

^[5] https://www.plansponsor.com/cfpb-commonwealth-introduce-automatic-emergency-savings-initiative

^[6] https://www.bcgbenefits.com/blog/new-plan-designs

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‍These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.