Congress wants to make it easier for you to save for emergencies, but their solution may not help the working class.
If you’re struggling to save for emergencies, you’re not alone. Roughly 40% of Americans don’t have any cash on-hand for emergencies, according to Forbes. And the problem doesn’t just affect low-income families. Investopedia found that 25% of families that earn $150,000 or more per year don’t have emergency savings either. So, emergency savings seems to be a universal problem in America. That may explain why Congress is working so hard to find a universal solution – namely, Universal Savings Accounts.
What are Universal Savings Accounts?
A USA Account is a new type of tax-advantaged savings tool that’s designed to encourage Americans to save more money. There are already plenty of accounts like this in existence today:
- 401(k) and IRA accounts for retirement
- Health Savings Accounts (HSAs) for medical expenses
- 529 plans for college savings
- ABLE accounts to help families raising children with disabilities
But Congress wants to create a new account that encourages savings specifically for emergencies. So, there are currently two bills being debated in Congress. The Family Savings Act of 2018 comes from the House and creates Universal Savings Accounts (USA accounts). That bill has already passed. There’s a different bill in the Senate that has a much clunkier name – the Strengthening Financial Security Through Short-Term Savings Accounts Act of 2018. That bill also creates a short-term savings account like the USA, but with a few key differences.
A USA account would be a short-term savings account that would function similarly to a Roth IRA without any age requirements attached.
- Savers could contribute up to $2,500 per year of after-tax income (that’s the income you take home in your paycheck).
- The money contributed would be invested, so it could grow with interest earnings.
- Any money you withdraw, including those interest earnings, would not be taxable. In other words, you wouldn’t have to pay income taxes on what you take out.
The big advantage is that you could withdraw money anytime you need it. If you have a retirement account, like a 401(k), you can’t take out funds without penalties until age 59½. People often borrow against their retirement accounts when they’re strapped for cash. But that can delay your retirement and could mean that you have to keep working.
How does the Senate’s account concept differ from Universal Savings Accounts?
The Senate’s idea to help Americans save isn’t to create an entirely new account like a USA. They want to create something known as a “sidecar account.” Basically, if your employer offers a 401(k) plan and you contribute, you can set up this sidecar account.
- You’d set a limit for how much emergency savings you want to maintain in this sidecar account.
- Your employer would take money out of your paychecks automatically until you reached that set amount.
- Then once the amount is reached, your contributions go back to being pre-tax contributions to your 401(k).
- Anytime you take money out, your contributions switch back until your set balance is reached again.
The Senate’s plan is definitely more confusing, although they do have a nice setup for a pilot program that would start participating employees out with $400 free dollars. But, the Senate’s version hasn’t even gone to the floor yet for a vote. So, there’s no telling which version will eventually pass Congress.
Will Universal Savings Accounts help you if the bill becomes law?
“The truth is that average American families under-utilize the tax-advantaged savings accounts we already have,” says Gary Herman, President of Consolidated Credit. “Only about a third of workers who are eligible for a 401(k) actually have one. And 31% of workers simply choose not to participate, even when their company offers a match program. That’s free money that’s just being left on the table.”
The statistics for other savings tools aren’t much better…
Only 22 million Americans have an HSA account for medical expenses – that’s less than 7% of the population. These plans are problematic to use because you must be enrolled in a high-deductible health insurance plan. That means out-of-pocket medical expenses each year can be high, which isn’t good for families living paycheck-to-paycheck.
And when it comes to saving for education costs in a 529, only about 3% of Americans use a 529 plan. What’s worse, only 29% even knew what a 529 savings plan was.
And many experts say that tax-advantaged savings plans disproportionally benefit the rich.
“High-income households are, by far, the biggest beneficiaries of tax-free savings,” argues Howard Gleckman, a Forbes contributor. He says an “analysis for retirement accounts finds that the highest income 20 percent of households (those making $153,000 or more) get nearly all the benefits of those savings accounts.”
Why Universal Savings Accounts could be better than other tax-advantaged savings
But Herman argues that Universal Savings Accounts may be more attractive to average Americans because they don’t have many of the limitations that other tax-advantaged savings tools come with.
“There are no early withdrawal penalties like you have with a 401(k) and no strings attaching it to something like a high-deductible health plan like an HSA,” Herman points out. “That makes the USA accounts more flexible, which is what families living paycheck-to-paycheck need to encourage them to save. Average families can’t afford the risk some of the other savings tools. They can’t afford high-deductible health plans or the potential of facing withdrawal penalties if they need the money in a 401(k). As long as Congress keeps USA accounts flexible, I think more families will see the benefit.”
When is the right time to use a tax-advantaged savings account?
Until Congress decides to pass a bill that implements USA accounts, Herman says people should still seriously consider the benefits of other tax-advantaged savings accounts.
“I think 401(k) plans and 529 college savings plans are the most useful savings accounts for average Americans,” Herman says. “Many 401(k) plans offer matching, where your employer agrees to match each dollar you contribute with a certain amount. For example, it’s common for employers to give you 50 cents for every dollar you contribute up to 6% of your annual salary. That’s huge. Then you also have 529 savings plans, which as of 2018 can now be used for K-12 education expenses, as well as college.”
If you’re working to get out of debt, Herman says it’s the perfect time to get educated about these accounts. That way, you’ll have a good use for the money you’ll save on credit card bills once you are debt-free.
“Start thinking about the future now,” Herman encourages. “If you’re enrolled in a debt management program now, you know exactly how long it will take to graduate. Once you do, you can take the money you were using to pay off your credit cards and invest it in one of these tax-advantaged savings accounts. That way you can finally start earning interest, instead of paying it to someone else.”