Americans have a hard time putting money away: 44 percent of Americans said they could not come up with $400 to cover an emergency expense in 2016. According to a brief from the Aspen Institute, a policy nonprofit, “one-third of Americans struggle with income volatility,” and 60 percent of Americans have experienced an unanticipated large expense in the past year that half had not financially recovered from six months later.
Besides the toxic combination of rising cost of living and shrinking wages, part of the reason this happens is because we don’t have good options for short-term emergency fund savings. Most of the investments available, that we use for goals like home ownership, college and retirement, are long-term vehicles, like 401(k)s, 529 accounts, etc. And retirement is given the most attention of all: As the Aspen Institute notes, employers contribute to our retirement plans, financial institutions service them (providing advice and asset management) and there’s a whole industry built to advise you on how to maximize them.
There’s nothing remotely comparable for short-term saving, which means we often treat our retirement accounts like emergency funds (this article from the Wall Street Journal notes that people auto-enrolled in 401(k)s may even take on more debt), tapping into them when we have an unexpected medical bill or home repair, and incurring penalties.
Some policy advisors see sidecar accounts as a way to bridge the gap between short term and long term saving. Here’s what to know about this particular savings vehicle.
How sidecar accounts could fill the short-term savings gap
Before the 401(k) became the retirement vehicle of choice for employers, they offered something called a thrift savings plan. Thrift plans were savings accounts that employees contributed to after-tax, which made withdrawals tax-free, and employers attached them to long-term savings plans. That’s where the term “sidecar” comes in: It’s a dual savings system.
What differentiates these accounts from what we think of as a normal savings account is how they’re funded. One option is for to employers sponsor them, and money is automatically deposited, like your retirement account now. Once you hit a certain threshold, contributions are then rerouted to the long-term retirement account, and if you use some of the sidecar money, it’s replenished before you continue contributing to the retirement fund. It’s supposed to increase the liquidity of your money so you have it when you need it, but are still consistently putting something aside.
On top of the benefit of more liquid savings, the Aspen Institute writes that the sidecar is a system that behavioral economists, like Nobel Prize winner Richard Thaler, like, because it could help savers better mentally account for their money and resist temptations to tap into their retirement fund.
An account more psychologically associated with short-term needs may help clarify which account is for which needs,” says the brief. “Subtle differences in how one frames each account (e.g., what the account is called, how the accounts are partitioned, or how easy it is to view an up-to-date balance) can be important when using lessons from mental accounting to nudge consumers toward specific action.
There are some drawbacks, of course. If it’s tied to your employer or a defined contribution plan, then this kind of plan doesn’t do much to help the growing number of freelance and gig economy workers who already are disadvantaged when it comes to saving. There’s also the question of how best to move it from employer to employer, and what role, if any, the government should play.
How to save more now, with or without a sidecar
Still, making a better system for short-term saving would be for the betterment of Americans’ finances. As the Aspen Institute notes, apps like Digit and Qapital, which you can use to automatically put money away into a savings account separate from your traditional account, sort of work like sidecar accounts (though they’re missing the connection to your retirement plan). It could also be modeled off of something like the Treasury Department’s myRA program.
The key, as noted above, is the compartmentalization. While you may not have a sidecar account, you can open separate savings accounts in different apps or with online banks that let you give nicknames to your accounts, and automate saving a portion of every paycheck. Regardless of how you set up your emergency fund savings, the bottom line is that tapping into a retirement account for expenses—and paying the hefty penalties—should be a last resort rather than anyone’s go-to savings strategy.