SECURE 2.0 Series Part 5: A Little More SECURE-ity – Emergency Savings in Your 401(k)
Employees, especially those far from retirement, are sometimes hesitant to put money into their employer’s 401(k) plan, knowing that their money won’t be available to them if unexpected expenses arise. Congress and the Biden administration, recognizing the long-term benefit of incentivizing retirement savings, included two new means for plan participants to access emergency funds in the new “SECURE 2.0” legislation, which was signed into law at the end of last year. We provide overviews of SECURE 2.0 here and here, and below discuss these new emergency distribution and Roth emergency savings account options.
Effective for plan years starting on or after January 1, 2024, 401(k) plans (along with 403(b) plans, 457(b) plans and IRAs) may allow participants to access up to $1,000 of their account balance (including pre-tax contributions) without penalty, in the event of an “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.” This new plan feature is modeled after certain other special in-service distribution options—namely, qualified birth/adoption distributions (QBADs) and the coronavirus-related distributions (CRDs) allowed under the CARES Act. Participants need only self-certify their need for the emergency distribution in order to request it.
Emergency distributions may be requested once per calendar year. However, a participant may not take another emergency distribution from the same plan or IRA within three years, unless the participant has already rolled their prior distribution back into the plan or IRA (as described below), or contributed to the same plan or IRA in an amount at least equal to their prior distribution.
As with QBADs and CRDs, a participant who takes an emergency distribution can also roll the distribution back into the same plan or into an IRA within three years to avoid taxation on the distribution. If the amount is rolled back into a plan/IRA in a later year, however, it will require an amendment of the participant’s tax return for the year of the distribution.
Roth Emergency Savings Accounts
Also effective in 2024, plans may allow participants who are non-highly compensated employees (i.e., for 2024, those who earned less than $150,000 in 2023) to contribute up to $2,500 in post-tax deferrals to an emergency savings account under such plan, which will be treated as Roth contributions. Sponsors may even elect to set up automatic enrollment in this plan feature, with contributions of up to 3% of a participant’s pay until the contribution limit is hit, unless a participant affirmative opts out.
Of note and likely key for both plan administration and investment communications – participants’ emergency savings account contributions must be invested in a manner that preserves capital – e.g., riskier investments that may be available under a plan, such as equity, aren’t allowed.
Plan sponsors may not themselves contribute amounts to participants’ emergency savings accounts but are required (if their plan provides for matching contributions) to match any emergency savings account contributions by putting the corresponding match into the non-emergency savings account portion of the plan.
Participants may withdraw from the emergency savings account on at least a monthly basis, penalty free (though plans may charge a fee after the first four withdrawals per year). The legislation does, however, give plan sponsors some authority to prevent participants from using these accounts in a manner other than that intended by the SECURE 2.0 Act of 2022, by putting money into the emergency savings account, receiving the match, and then immediately withdrawing their own contributions.
When a participant with an emergency savings account balance terminates employment, a plan must allow for their balance to be (1) rolled into their plan Roth account (if applicable), (2) rolled into another plan or IRA, or (3) distributed to the participant. Since contributions to the emergency savings accounts are treated like Roth deferrals, any distribution (including earnings) will not be taxable to the participant.
While each of these new features are optional for plans, we do expect they will be implemented by many sponsors, and that they will be popular with potentially hesitant plan participants.