Vanguard: Emergency Savings Mean Retirement Savings

Employer-sponsored 401(k) plans help millions of Americans save for retirement, but not all those savings make it to retirement age, according to new research from Vanguard.

According to the firm’s June research note, “Emergency Savings Protect Retirement Savings,” one-third of Vanguard plan participants who left their jobs in 2023 withdrew their 401(k) balance as a cash lump sum—often incurring withdrawal penalties and jeopardizing their retirement readiness.

“It’s really about financial planning,” says Kelly Hahn, head of retirement research at Vanguard and co-author of the study. “We can’t emphasize [enough] the need for retirement wealth and having people achieve retirement security when we don’t think about the short-term liquidity challenges and needs.”

The research on which the note is based, conducted in July 2024, found that participants with emergency savings contribute more to their 401(k)s and take fewer withdrawals both during and after they leave a job. For example, those with at least $2,000 in emergency savings contributed an additional 2.2% of income, were 19% less likely to take a loan and were 17% less likely to take a hardship withdrawal than those without. Notably, those with emergency savings were 42% less likely to cash out.

Participants without adequate emergency savings may face liquidity shortages when changing jobs and use cashed-out retirement balances to replenish their liquid accounts, pay off credit card debt or address other more pressing financial needs, the firm stated in its report.

Income Method Matters

PLANSPONSOR asked Hahn what drove those with higher emergency savings balances to contribute more to their retirement accounts.

“When people have the resilient foundation to build their balance sheet, they tend to manage their financial planning in a way that allows them to save more toward their retirement,” says Hahn.

She also suggests hourly workers as an example of those who might struggle more with financial planning. She says that volatile monthly income, compounded with life’s potential “spending shocks,” make it difficult to manage finances—including figuring out how much to save for retirement.

Hourly workers in plans administered by Vanguard had cash-out rates ranging from 10 to 15 percentage points higher than salaried workers with similar annual incomes. The typical hourly worker—making a median annual income of $64,000—saw income fluctuate by about $800 from month to month, or a 15% differential on monthly earnings of $5,333. Salaried workers’ monthly incomes fluctuated by only $267 per month, with only positive deviations due to bonuses.

To assess the link between income volatility and leakage of plan assets, Vanguard surveyed 2,300 participants in retirement plans the firm administers. When asked how confident they were that they could pay for an emergency that costs about $2,000, 39% of hourly workers said, “entirely confident.” In comparison, almost double (71%) the rate of salaried workers said the same.

How to Help Employees Save, Starting Today

According to Hahn, the SECURE 2.0 Act of 2022 allows plan sponsors to help their employees build emergency savings, too—in “two flavors.”

One is the $1,000 emergency withdrawal that participants are allowed to take out every calendar year, Hahn says. If a participant has not paid back a previous withdrawal, however, they must wait three years to take another.

The second tool employers can adopt is a pension-linked emergency savings account. PLESA contributions are made after-tax, as part of a Roth structure, open to non-highly-compensated employees, and are capped at $2,500 annually.

Hahn also suggests plan sponsors offer their participants financial wellness education covering emergency savings.

“Auto-enroll, auto-escalation, some of those plan design features … have worked really well to almost force savings, right” Hahn asks. “I think the downside of that has been that employees become hands-off when it comes to managing their own finances. There has to be an emphasis on building a greater overall financial wellness, not just thinking about retirement savings.”

While the Vanguard study did not ask participants where they kept their emergency savings, Hahn suggests that where cash is kept matters as well.

“There are many different vehicles that you can save into … but not all of those cash accounts are created equal,” says Hahn. “We really emphasize the need [for employees] to check out high-interest-yielding accounts.”

She says that as workers are thinking about building an emergency reserve, their cash should also be “put to work.” Vanguard, for instance, offers the Cash Plus Account, designed to offer a competitive yield on short-term savings. Financial institutions such as Morgan Stanley, Goldman Sachs and E*Trade offer similar options.