AutoSave Concept Paper
Policy Paper
Nov. 12, 2008
Introduction
America used to be a nation of thrift. Saving was seen as beneficial both individually and collectively. Against a backdrop of increased access to quick credit and short-term loan products, and a financial marketplace with new and constantly changing products that add complexity to a consumer's decision making process, both individual and collective saving has declined precipitously. Historically low levels of personal savings and high levels of consumer debt place in jeopardy the economic stability of working families. The current credit crisis, which is translating into job losses and social service cutbacks, exacerbates these difficulties. The resilience of American families depends both on being able to save and accumulate assets and being able to draw down these resources over an often-short time horizon that corresponds to household emergency and income-smoothing needs.
The following paper discusses the rationale for addressing saving among lower-income workers, demonstrates the need for saving, particularly flexible saving, and describes potential uses and benefits of an automatic saving mechanism.
AutoSave Concept Overview
Federal and state governments support a variety of programs and policies to encourage saving. However, most of these are focused on long-term goals, with consequent restrictions on use and penalties for withdrawals other than those tied to the specified goal. Moreover, because the primary incentive used is a tax benefit, the programs mainly benefit higher-income households. Yet many households would benefit from a pool of savings that could be tapped for emergencies and shorter term capital uses (such as to purchase a car). Households also could use such savings to begin to save and invest more extensively. Currently no systematic saving program exists to intentionally encourage non-restricted saving that is not oriented toward specific long-term goals.
AutoSave is a unique saving plan that automatically diverts through payroll deduction a small amount of post-tax wages into a savings account. AutoSave's design incorporates key factors that encourage saving, such as facilitation of automatic transfers to a savings account through an existing system (here, payroll deduction) and use of strategies that make putting money into a savings account - rather than not saving - the preferred option. To participate, employers would direct deposit a small amount of wages each pay period into individual AutoSave accounts on behalf of participating employees. Workers would have the flexibility to opt- out of the system (as well as to increase or decrease the amount saved), would have control of their funds, and would be able to withdraw funds at any time without financial penalty.
This new infrastructure, near-seamlessly enabling individuals to contribute small amounts of their wages into an accessible, non tax-advantaged savings account, will be especially valuable for individuals who have limited liquid assets, and who may otherwise be forced to meet emergency liquidity needs with high-cost emergency loans. Moreover, connecting AutoSave to the workplace may also foster a habit of saving.
Asset Poverty and Household Financial Instability
The need for unrestricted saving can be tied to high levels of "asset poverty" and household financial instability. Asset poverty - the inability to meet basic needs (surviving at the poverty level) for three months with existing financial resources if a household's income were disrupted - provides a more complete picture of family well-being than income, which only measures a household's flow of funds. Levels of asset poverty tend to be greater than measures of income poverty, with some studies showing that asset poverty reaches into the middle class.[1]
At least one quarter of Americans are asset-poor. The numbers double in the black and Hispanic populations. Among working families with children, who earn up to 200 percent of the federal poverty level, 30 percent have zero or negative net worth and barely half have a bank account-those with a bank account have a median balance of $800.[2] The Urban Institute estimates that eight out of every ten low-income families are asset poor.[3]
In recent decades, families have shown a steady decline in their ability to weather a financial emergency. Compared to 2000, when nearly 40 percent of families held three months worth of income in financial wealth resources, only 29 percent were financially prepared for an unspecified emergency expense in 2007.[4] Meanwhile, the personal bankruptcy rate rose 85 percent between the first quarter of 2006 (after the recent Bankruptcy Code changes became effective) and the fourth quarter of 2007, to 2.7 filings per 1,000 people.[5] Additionally, rising levels of credit card defaults and home foreclosures indicate households are facing financial stress and rapid depletion of their personal wealth. The ongoing credit crisis, now moving decisively into job losses and government service cutbacks, will put further strain on households.
The levels of asset poverty and financial insecurity call for attention to enhancing the opportunity to and actual saving of all Americans, but particularly those at lower income levels.
Saving Rates, Patterns, and Barriers
The national personal saving rate offers another perspective on the financial state of households. The U.S. Department of Commerce has chronicled a startling decline in the personal saving rate, the portion of disposable income remaining after total personal outlays. Having fallen below zero in 2005 for the first time since the Great Depression, the personal saving rate remained low, at around 1 percent, through 2007.
Recent polling of a nationally representative sample of adults showed that 52 percent do not believe that they are saving adequately, and 17 percent report that they "cannot afford to save at all."[6] Large expenses-expected and unexpected, low or unsteady income and debt repayment hinder household saving efforts, according to this study's analysis of the reasons why even those who want to save are unable to do so. The current tightening of credit-and the playing out of the consequences of excessive leverage-make all the more clear the need for families to save, even as saving becomes more difficult because of the economic contraction.
Direct Deposit Facilitates Saving
Research supports the benefits of making saving possible with direct deposit. The Department of Treasury surveyed Americans' preferences for money management and found that direct deposit ranked above ATM cards and check books as their most vital tool for managing personal finances.[7] An evaluation of the American Dream Demonstration, open to individuals whose income does not exceed 200% of the Federal Poverty Level, showed that Individual Development Account (IDA) participants with direct deposit saved more than IDA participants who did not use direct deposit.[8] Non-IDA-related field research suggests that direct deposit increases saving rates and amounts. A recent survey of low-income households in two New York communities reported that individuals who set aside money through automated contributions saved more than non-automated savers. Of the sample, 16 percent saved automatically and had average saving amounts ($3,000 per account) more than twice the savings amount of the non-automatic savers ($1,200 per account).[9]
According to nationally representative research by the Consumer Federation of America (CFA) in May 2008, 66 percent of all employees (78 percent of employees with access to direct deposit) receive their pay through direct deposit. The direct deposit numbers are lower for low- and moderate-income workers. Nevertheless, 49 percent of all low-income employees (earning $25,000 or less) and 57 percent of all moderate-income employees (earning $25,000-$35,000) receive their pay through direct deposit. Designing a saving structure so that the first choice presented to the individual is to directly deposit earnings and to put a portion of the money into a saving account may help close the gap between access and actual take up of the direct deposit option.
The CFA survey also found that nearly 60 percent of respondents who use direct deposit had the option to "split directly deposited paychecks between checking and saving" at their bank or credit union.[10] Yet only 39 percent of them choose to use the option. Among all the working adults surveyed, only 13% percent of the survey sample reported splitting their paycheck between checking and saving accounts with direct deposit. [11]
The disparity between the desire to save and the decision to save more through automatic transfers could be addressed with an AutoSave plan. Further, awareness of AutoSave might improve take-up of direct deposit - a payment method with cost-saving implications for employers and employees. In addition, AutoSave may also offer an opportunity to educate consumers about the insured status of checking and savings accounts, critical given the current weakness of - and consumers' uncertainties about using - certain financial institutions.
The Need for Flexible Saving
Saving increases an individual's likelihood of owning assets[12] and becoming less reliant on non-traditional and personal network sources of credit.[13] Savings that are fully under an individual's control are valued as a form of self-insurance, a key ingredient in one's sense of security,[14] and as a personal safety net that can be tapped in the event of unanticipated expense. These are "flexible savings," in contrast to savings that are restricted as to use (often by the tax laws), such as for retirement or for medical expenses. For households with fewer resources, flexible savings can be especially powerful as a lifeline to weather financial downturns or as the initial building blocks of asset accumulation.
It is important to focus on this type of non-restricted saving because households either do not set aside money for unexpected expenditures or underestimate the amount of emergency savings needed. Analyzing polling results for 2004-2008, the Consumer Federation of America found that households with incomes below $25,000 predict spending $1,500 on unforeseen expenses, but ultimately spend approximately $2,000 yearly.[15] The problem this presents is amplified by the fact that less than one third of households in this income bracket hold a savings account and as few as one third of those who do possess a savings account have at least $500 set aside.
The inability to weather fluctuations in expenses that exceed income sends households into a cascade of unfavorable financial decisions and consequences. New research finds a correlation between being low income (earning less than $25,000) with low levels of emergency savings and trouble paying monthly bills and other payments (rent, mortgage), bouncing checks, and making only minimum card payments.[16] Not surprisingly, the rate of reporting "unfavorable financial experiences" is higher for those with fewer savings. An individual with no savings is four to ten times more likely to report an "unfavorable financial experience" than an individual with $500 in savings.[17] Recent survey research by the Center for Financial Services Innovation and the New York City Department of Consumer Affairs confirms that the underbanked consider saving for unexpected emergencies to be the most important saving purpose or goal.[18]
Lack of savings can also push households into using expensive forms of credit. The frequency of payday loan use and the sizeable income lost to fees suggests that a large share of the working population experiences liquidity problems and may not have access to alternatives to high-priced credit.[19] Each month, 15 million people, most of whom earn $18,000-$25,000, visit payday lenders, where they are often charged an effective interest rate (expressed as an annual percentage rate) as high as 300-400%.[20] According to the CFA research, consumers are more tolerant of a low return on savings than they are of bounced check fees or "unfavorable financial" products or arrangements.
These findings have two important implications. First, $2,000 is a reasonable target to set as a savings goal for low and moderate income households. Second, a major opportunity cost of lack of saving is using a costly credit product. Even at a low interest rate, or a negative real interest rate, setting aside funds in anticipation of an emergency is for most people a better choice than pursuing high-priced credit or a short-term loan in the event of an unplanned expense. That consumers, particularly lower-wage workers, understand the importance of saving for emergency expenses but do not have the savings plans or structures to enable it, implies a gap in product offering that could be met with automated regular direct deposits into saving. Moreover, the recent financial problems in the credit and banking industries may mean that credit will be harder to obtain for the next several years. Under these conditions, AutoSave may have more appeal to workers, and play a more important role in covering emergency expenses.
Successful Saving Strategies for Low- and Moderate-Income Households
The great majority of large-scale saving efforts target retirement planning and saving for higher education, and are most successful among higher-income households for whom the tax advantages provided are meaningful. Over the last ten years, however, initiatives to encourage saving of refunds at tax-time,[22],[23] salary advances at the workplace,[24] use of individual development accounts[25] and escrow accounts[26] have been establishing credibility for the proposition that low and moderate income workers can, will, and do save.
Behavioral economics is a field of study premised on the assumption that individuals do not consistently behave as rational economic agents in constant pursuit of welfare maximization. Rather, humans are prone to procrastinate, to not take advantage of opportunities in their best interest, and to struggle with the decision-making process when given too many choices. Behavioral economists performing applied research around retirement savings have shown that automatic enrollment is an effective strategy that encourages more savings activity, and leads to increased worker participation in 401(k) plans and other retirement salary reduction plans. Automatically enrolling employees in 401(k) plans increases both participation and amount saved and has been shown to have the largest effect on those groups that previously had the lowest participation rates: blacks, Hispanics, young, and lower-earning workers.[27] The Save More for Tomorrow (SMarT) program demonstrated that employees will take advantage of structured savings plans that facilitate their savings. While studying SMarT, a program that helps employees automatically pre-commit their future salary increases to a retirement plan, researchers found that the average savings rates of enrolled participants increased from 3.5 percent to 13.6 percent over four annual pay raises.[28],[29]
Automatic enrollment and direct deposit are proven ways in which positive consumer savings behavior can be encouraged. Moreover, they require changing relatively small features of an individual's financial environment.
A Potential Solution: The AutoSave Model
Given the above, it is logical to consider - and do the necessary experimental research to learn about the effectiveness of - a system in which employers use their unique positioning to facilitate the accumulation of non-restricted savings by their employees. As discussed above, working households require funds for unanticipated expenses, but typically do not set aside enough or any money for these purposes. For many non-savers, the barrier to saving is access to a savings account or plan that simultaneously encourages the setting-aside of money and allows access to that money in an emergency or for relatively large anticipated expenses (e.g., purchase of a computer or a car). For others, overcoming the inertia to enter a bank lobby and choose among an array of product offerings is the major challenge. AutoSave will streamline account opening with a design that minimizes the need for consumer decision-making or paperwork. Contributions will be automatically made with direct deposit transfers from take-home pay to AutoSave accounts. The accounts will be structured to both encourage saving and not penalize a saver who needs access to funds. Enrollment will require minimal action by the employee - only his or her consent and signature. With the default choice to initiate AutoSave contributions, participation is made easier than non-participation.
Estimated Savings Under AutoSave
While we think AutoSave would benefit the entire population, we believe it would be especially beneficial to low and moderate income workers, who are least likely to participate in or benefit from the government's major institutional saving policies such as tax incentives directed to retirement savings or home ownership.
Table 1 presents the 2006 household income distribution. AutoSave would be available to all employees, but would likely be most useful to those with household incomes in the second and third quintile, earning $20,036 - $60,000. According to the 2004 Survey of Consumer Finances, fewer than half of the households with incomes in this range reported saving during the previous twelve months.[30]
Table 1. Income Distribution 2006 (in 2006 dollars)
|
Income Percentile |
Income |
|
1st quintile |
$20,035 and below |
|
2nd quintile |
$20,036 - $37,774 |
|
3rd quintile |
$37,775 - $60,000 |
|
4th quintile |
$60,001 - $97,032 |
|
5th quintile |
$97,033 and above |
Source: U.S. Census Bureau, Historical Income Tables-Households, "Income Limits for Each Fifth and Top 5 Percent of Households All Races: 1967 to 2006" table H-1.
Estimated AutoSave deductions and projected annual accumulated savings are calculated in the table below. As the table illustrates, contributing $25 every other week will accrue to approximately $600 over one year. This amount is less than three percent of take-home pay for the worker at the lower end of the earning spectrum and one percent of a worker's take-home pay if they earn $60,000 per year.[31]
Table 2. Estimated AutoSave savings for bi-weekly deductions of $15, $25, $40, $50[32]
|
Gross Earnings |
Net Income "Take-Home Pay"[33] |
Bi-Weekly Deduction |
Annual Savings |
Percent of Net Income Saved |
|
$25,000 |
$22,088 |
$15 |
$390 |
1.8 |
|
$25 |
$650 |
2.9 |
||
|
$40 |
$1,040 |
4.7 |
||
|
$50 |
$1,300 |
5.9. |
||
|
$40,000 |
$34,256 |
$15 |
$390 |
1.1 |
|
$25 |
$650 |
1.9 |
||
|
$40 |
$1,040 |
3.0 |
||
|
$50 |
$1,300 |
3.8 |
||
|
$50,000 |
$41,590 |
$390 |
$390 |
0.9 |
|
$25 |
$650 |
1.6 |
||
|
$40 |
$1,040 |
2.5 |
||
|
$50 |
$1,300 |
3.1 |
||
|
$60,000 |
$48,930 |
$15 |
$390 |
0.8 |
|
$25 |
$650 |
1.3 |
||
|
$40 |
$1,040 |
2.1 |
||
|
$50 |
$1,300 |
2.7 |
||
Potential AutoSave Policy Implications
The design and implementation of AutoSave may have legal, policy, and business implications for participating employers and financial institutions. In conversations with prospective pilot partners, we are identifying whether existing law and business practice would impede AutoSave's design and delivery system, and whether their resolution would require policy change.
[1] Robert Haveman and Edward Wolff, "Who are the Asset Poor? Levels, Trends, and Composition, 1983-1998" (working paper, Center for Social Development, Washington University, September 2000).
[2] Signe-Mary McKernan and Caroline Ratcliffe, "Enabling Families to Weather Emergencies and Develop: The Role of Assets," The Urban Institute, July 2008.
[3] Ibid.
[4] Christian E. Weller and Amanda Logan, "America's Middle Class Still Losing Ground," Center for American Progress, July 2008.
[5] Ibid.
[6] "More than Half of Americans Say They Are Not Saving Adequately," Consumer Federation of America, press release, December 10, 2007.
[7] U.S. Department of Treasury
[8] Michal Grinstein-Weiss, Kristen Wagner, and Fred M. Ssewamala. "Saving and Asset Accumulation Among Low-income Families with Children in IDAs," Children and Youth Services Review 28 (2006).
[9] Neighborhood Financial Services Study: An Analysis of Supply and Demand in Two New York City Neighborhoods Executive Summary, (New York City: New York City Department of Consumer Affairs, June 2008).
[10] Throughout this document, we generally mean the terms "banks" and "financial institutions" to include thrifts and credit unions in addition to banks.
[11] Stephen Brobeck. "Access to and use of Direct Paycheck Deposit: Findings of a 2008 Survey" Consumer Federation of America, July 2008. The definition of "employee" is limited to those receiving regular wages.
[12] Brian Bucks, Arthur Kennickell, and Kevin Moore, "Recent Changes in U.S. Family Finances: Evidence from the 2001and 2004 Survey of Consumer Finances," Federal Reserve Bulletin 92 (February 2006).
[13] Underbanked populations will often save through informal mechanisms (non-interest bearing accounts, safe deposit boxes, holding gold or jewelry to sell, etc), with 34% of underbanked respondents in a national survey reporting this type of savings behavior. Ellen Seidman, Moez Hababou, Jennifer Kramer. "A Financial Services Survey of Low-and Moderate-Income Households." Chicago: Center for Financial Services Innovation, July 2005.)
[14] Lisa McKean, Sarah Lessem, and Elizabeth Bax. Money Management by Low-Income Households: Earnings, Spending, Saving, and Accessing Financial Services, (Chicago: Center for Impact Research, August 2005.)
[15] Stephen Brobeck, "The Essential Role of Banks and Credit Unions in Facilitating Lower-Income Household Saving for Emergencies" Consumer Federation of America, June 2008. Draft
[16] Ibid.
[17] Ibid.
[18] Neighborhood Financial Services Study: An Analysis of Supply and Demand in Two New York City Neighborhoods Executive Summary, (New York City: New York City Department of Consumer Affairs, June 2008).
[19] At least 30 states do not cap the interest rate payday lenders can charge for providing a cash advance.
[20] The Commission on Thrift, For a New Thrift: Confronting a Debt Culture May 2008.
[22] Internal Revenue Service, Statistics of Income Division, November 2007.
[23] Internal Revenue Service, IRS Split Refund Information as of August 17, 2007. Per email communication with Donald Dill, Stakeholder, Partnerships, Education, and Communication (SPEC) Headquarters, February 26, 2008
[24] Brigitte Madrian and Dennis Shea."The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior." Quarterly Journal of Economics 116, (2001) 1149-1187.
[25] Mark Schreiner, Michael Sherraden, Margaret Clancy, Lisa Johnson, Jami Curley, Min Zhan, Sondra G. Beverly, and Michal Grinstein-Weiss, "Assets and the Poor: Evidence from Individual Development Accounts" in Inclusion in the American Dream: Assets, Poverty, and Public Policy. Ed. Michael Sherraden. (New York: Oxford University Press, 2005).
[26] FSS Partnerships, "HUD Program Evaluation Confirms FSS' Success in Promoting Self-Sufficiency and Asset-Building," September 7, 2004; Brigitte Madrian and Dennis Shea."The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior." Quarterly Journal of Economics 116, (2001) 1149-1187.
[27] Brigitte Madrian and Dennis Shea."The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior." Quarterly Journal of Economics 116, (2001) 1149-1187.
[28] Richard Thaler and Shlomo Benartzi. "Save more Tomorrow: Using Behavioral Economics to Increase Employee Saving" The Journal of Political Economy 112 (February 2004): 164-187.
[29] Results for workers at a midsize manufacturing company who self-selected into the SMarT program and reported saving very little prior to enrolling in SMarT.
[30] Brian Bucks, Arthur Kennickell, and Kevin Moore, "Recent Changes in U.S. Family Finances: Evidence from the 2001and 2004 Survey of Consumer Finances," Federal Reserve Bulletin 92 (February 2006).
[31] Savings expressed as a percent of net income was not more than one percentage point greater when expressed as a percentage of gross earnings savings; hence, the omission of percent of gross earnings from the table.
[32] Notes: Gross earnings assume no additional deductions claimed by household. Net Income, or, "Take-Home Pay" is estimated by subtracting the appropriate average tax rate, FICA tax (7.65% of wages), and average state tax (4% of wages) from gross income. The Average tax rate assumed Married Joint Filing status, with one dependent. This household size and filing status selected because in 2006, the average U.S. household size was 2.6.
Source: Commonwealth Financial Network, Tax Margin Calculator for the average tax rate on each gross earnings levels: https://home.commonwealth.com/backoffice/Planning/Calculators/java/TaxMargin.asp