Unrestricted Savings: Their Role in Household Economic Security and the Case for Policy Action

Low savings levels are a significant source of economic insecurity for scores of American families. Households need access to unrestricted funds that can be deployed flexibly to bridge short-term cash-flow gaps and to build their own safety net to prevent small shocks from destabilizing their financial security. The amount of funds required to make a difference will vary; depending on the size of the household and other conditions it could range from $2,000 to $5,000. The presence of savings on a family’s balance sheet can reduce the need to borrow, either informally or from high-cost creditors, and preserve financial health over the long term.

Unrestricted savings refers to a range of formal (i.e. held in a depository or investment product) and non-formal (i.e. “under the mattress”) savings options that are accessible for an individual’s discretionary use. In contrast, more-restricted savings include investments that accumulate over a longer period of time—for instance, retirement savings generated throughout a worker’s tenure, or home equity. A primary purpose for unrestricted savings is to smooth income—that is, addressing a cash shortfall when expenses exceed household income or ability to pay.

Low- and moderate-income families and those with low savings are challenged to accumulate savings by a variety of factors. Stagnant or low wages leave households with limited discretionary funds available to save for future use.Strict and inconsistent eligibility guidelines for public assistance programs can discourage saving and developing formal attachment to depositories and perpetuate the belief that a modest amount of savings or assets will disqualify one from public assistance. Being “banked” with a depository and being eligible for savings products are also requisite steps to safe saving. Individuals frequenting informal check-cashers, remittance providers, and payday lenders do not have access to savings opportunities at these non-bank establishments, contributing to low saving by these customers.

Moreover, there are rational arguments to defer saving. The need to buy basic necessities or repay debt may take precedence in certain scenarios. The structure of today’s basic account can discourage low-balance savers. Compared with the often modest amounts contributed to emergency-use savings accounts, fees for maintaining the accounts are high. In a low-interest-rate economy, it may also indeed be rational to encourage someone not to save, if the rate of inflation outpaces the rate of return on a savings account.

Behavioral economics helps explain why individuals under-save, and face barriers to save that are seemingly irrational. This working paper applies four of these principles to the unrestricted saving context; including, temporal discounting, loss aversion, information overload, and awareness of the role of emotion and past experience in human decision-making. This manifests in failing to act on preferences to save and reacting emotionally, if not illogically, when making financial preparedness decisions.

Behaviorally informed policies show promise in leading to behavior change and increasing savings. Policymakers should use a behavioral lens to capture a more complete depiction of the human decision-making processes, to create policies to promote savings, not deplete it.

This analysis confirms that large segments of the population likely have insufficient levels of unrestricted savings, which is troubling because of the correlation between presence of liquid savings and avoidance of costly missteps. Having urgent liquidity needs but no liquid savings to meet the needs can result in households making nontraditional or unproductive economic choices. Households may forgo necessary purchases (i.e. food, medicine, winter clothing), rely on overdraft coverage (i.e. a loan made through their checking account), borrow from their employer or social network, or take on a small-dollar loan.

Unfortunately, public policy fails to promote unrestricted savings. Most of the attention given to savings in policy circles has focused on restricted-use savings as a means to build wealth over the long term and promote retirement security. This has created a gap in the policy landscape since shorter-term, more accessible savings are needed by a wide spectrum of the population to reinforce a personal safety net.

There are a number of ways that public policy could be deployed to more effectively promote unrestricted savings and significantly enhance the economic security of large segments of the population. First, policy emphasis should be placed on addressing and removing barriers where they can be identified (e.g., reforming asset tests and ChexSystems requirements). Secondly, policy could potentially play a role in improving product options. Thirdly, policies should encourage the use of existing infrastructures where they have proven to be successful in spurring saving. These include a greater promotion of direct deposit and split pay between multiple accounts. Lastly, public sector entities involved in financial inclusion pilots and campaigns should be required to demonstrate results for their investment, and heed encouragement by public leaders to innovate.

In the medical care context, an emergency room visit will cost all involved—patient, provider, and insuring party—much more than affordable, preventive health care. Similarly, the cost of not saving is much higher to families and society than the cost of regular, small deposits to a simple account.

Households use unrestricted, liquid savings to weather economic shocks and to protect themselves from future unfavorable events. With evidence to confirm that the presence of liquid assets decreases the risk of financial hardship, it behooves policymakers to support the ability of households to save regularly in affordable, accessible mechanisms.

Please click here to read the entire working paper.