Rethinking Retirement

Tom Armstrong

How often have you heard someone say they are not saving for retirement because they can’t afford to risk locking up their money for the long term? What if they had more financial flexibility when unexpected expenses arise? A provision within the SECURE 2.0 Act of 2022 offers an opportunity to add this near-term financial flexibility to retirement savings. One of the law’s provisions allows employees to withdraw up to $1,000 penalty-free from their 401(k)-retirement account once a year for financial needs relating to personal or family emergency expenses.

Nick Maynard

The provision could have a powerful impact on workplace savers’ financial security. A retirement plan participant could request up to $1,000 or less for unexpected expenses, which will be transferred via ACH to their bank account within three to five days. It can be repaid by ongoing retirement account contributions. Plan participants must repay the emergency withdrawal amount within three years or pay income tax on the withdrawal, and only employees of plan sponsors and recordkeepers that adopt the benefit are eligible.

Saving for emergencies is a significant concern for Americans earning low-to-moderate income. The increased stress people feel from this lack of emergency savings can significantly impact their quality of life and their ability to be productive at work. Historically, retirement savings have been viewed as a source of savings in a financial crisis—even with a penalty for early withdrawal. A Voya study found employees without sufficient emergency savings are 13 times more likely to take out a hardship withdrawal from their retirement account than their peers with sufficient emergency savings, according to Voya data. The $1,000 emergency withdrawal option allows employees with an existing retirement fund to avoid taking out a loan or hardship withdrawal.

To fully understand the potential of the $1,000 option and how employees engage with it, Commonwealth and Voya have collaborated on a pilot as part of BlackRock’s philanthropic Emergency Savings Initiative to proactively market it to low- to moderate-income employees. Voya and Commonwealth created clear marketing materials to easily communicate the $1,000 emergency withdrawal process for employees. While more research is required, early findings suggest that the $1,000 emergency withdrawal option may encourage greater participation in the workplace retirement plan.

Increased plan participation and positive feelings

Offering the $1,000 emergency withdrawal provision could increase retirement plan participation, as employees often don’t enroll due to the lack of liquidity of their plan assets. Commonwealth research found focus group participants, comprised of employees of diverse ages, genders, and ethnicities earning less than $80,000 per year, responded positively to the $1,000 option, demonstrating that a penalty-free emergency withdrawal could positively impact how employees approach retirement savings. This is evident in Voya’s participant data, which shows that those who do feel financially secure—meaning they have emergency savings of three plus months of living expenses—on average, contribute about 50% more to their long-term retirement plan than those who acknowledge that they don’t feel financially secure. Not only do these individuals save more (51% more, in fact), but they are also, on average, on track for positive retirement outcomes and have a 14% higher income replacement rate, Voya’s research found.

The focus groups also documented that participants liked the $1,000 emergency option as an alternative to taking a loan or incurring debt—making it a crucial tool for creating financial stability and long-term wealth-building.

Lastly, focus group participants strongly believed that one should not withdraw from a retirement plan but described the $1,000 option as a “good backup” for emergencies.

Research regarding the impact of the Coronavirus Aid, Relief, and Economic Security Act’s removal of the 10% penalty on retirement plan withdrawals found just “modest usage” of coronavirus-related distributions, providing evidence that concern about too many withdrawals might be overstated. During the COVID pandemic, Voya found that those who took out coronavirus-related distributions often took more than needed, indicating that the option of taking a smaller initial withdrawal might be very beneficial to preventing leakage. The $1,000-emergency withdrawal is a starting point for employees in crisis that could help prevent more harmful leakage and offer the potential to increase retirement plan participation. Voya’s participant data for a large corporate employer reveals that 90% of participants who utilized the emergency withdrawal option continued to contribute to their retirement plans, suggesting that they managed to either partially or fully repay the withdrawn amount. Notably, 66% of participants that took emergency withdrawals in the first three quarters of 2024 have already completely repaid their emergency withdrawal, underscoring the effectiveness of this support mechanism in maintaining retirement savings momentum.

To be sure, there are still many unknowns about the impact of the $1,000 emergency withdrawal option on long-term retirement savings, but it has the potential to positively impact participation and regular contributions while stopping more significant leakage over time. Recordkeepers and employers have a valuable opportunity to provide meaningful emergency savings and retirement-building solutions by offering employees the $1,000 emergency withdrawal option and promoting it in ways that link it to plan participation and withdrawal concerns.

The provision is straightforward and viable for retirement administrators, and it takes a simple activation for plan sponsors to add to an existing plan. It can be coupled with the Domestic Abuse Victim Withdrawal Provision and Qualified Disaster Recovery Distributions provision, all of which plan sponsors should consider adopting to support workers, especially those earning LMI and experiencing emergency expenses to create a more comprehensive safety net. Adopting these features can be especially impactful for employees facing financial hardship. Employers have a unique opportunity to strengthen workforce financial resilience by promoting emergency savings solutions and educating employees on how to build a personal financial cushion. When communicated effectively, the emergency withdrawal provision not only provides a critical backstop for those without emergency funds—it can also help boost retirement plan participation among LMI workers.

Tom Armstrong is vice president, customer analytics and insight and head of the Voya Behavioral Finance Institute for Innovation at Voya Financial.

Nick Maynard is senior vice president at Commonwealth.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of PLANSPONSOR, ISS STOXX or its affiliates.