In an ideal world, planning family finances to meet needs would be clear-cut. Families could match expenses to regular income streams. But in the real world, cash comes in without predictability. And this uncertainty is on the rise, as household finances continue to teeter on shaky ground. Unless we develop more flexible options for families to save for what might happen next week and what might happen 20 years down the road, that ground will remain unstable.
In 2014, the Federal Reserve estimated that nearly a third of American households experienced significant income fluctuations, reflecting a level of income volatility 30 percent higher than it was in the 1970s. This uncertain income exacerbates the risks of having few resources to draw upon when life happens and inevitably leads to unexpected expenses like a health emergency or a car repair.
Unfortunately, when people don’t have access to even small amounts of money when emergencies hit, they are susceptible to falling into a number of financial traps in their efforts to attain liquidity. They may reach into retirement savings, tap home equity, take out a payday loan, or run up debt on a credit card.10 million households—and 30 percent of lower-income households—don’t own a basic transaction account. But it’s as true as it is unacceptable.
For a number of months, I have led a research team looking to identify better options. Most critical among our findings (which we have recently published in Flexible Savings: The Missing Foundation) is an urgent need for federal policies that support savings that can be accessed without penalty and at discretion as a means to strengthen the foundation for each families’ economic security. For starters, it is important to remove unnecessary barriers to savings for those with the fewest resources, such outdated eligibility rules that deny public assistance if families exceed even low levels of savings. Once all families are thus empowered to save, they must also have access to a basic transaction account insured by the FDIC. It’s hard to believe that almost 10 million households—and 30 percent of lower-income households—don’t own a basic transaction account. But it’s as true as it is unacceptable.
The next step is to rework the incentives. Current federal policy is limited—often in the form of tax subsidies for contributions to retirement accounts— to supporting long-term savings objectives. The rules governing these accounts discourage saving for shorter-term priorities by levying harsh penalties for “non-qualified” uses. But should we really consider making a mortgage payment or paying a utility bill as a “non-qualified” reason for a family to draw upon their savings?
Without savings that can be used flexibly, the majority of households are needlessly exposed to an array of common economic risks. Over three-fourths of American families would see their liquid savings exhausted by unanticipated expenses requiring less than a month of their total income. Only 39 percent of households report having set aside enough money in an emergency fund to cover expenses for three months. And even including all other financial assets like retirement accounts and mutual funds, 44 percent of households still wouldn’t have enough resources to live at the poverty level for three months without income. Existing policies not only directs the majority of benefits to those at the upper end of the income scale, but it also misses a vital opportunity to minimize the precarious nature of family finances.Opening up options for short-term savings doesn’t mean letting go of incentives for long-term asset building—far from it, in fact.
A better approach would be to provide a set of policies designed to secure each family’s financial foundation and encourage them to get started on a beneficial savings pathway. This means helping people build up assets for short-term uses during financially volatile periods while preserving other assets for long-term uses down the road. Opening up options for short-term savings doesn’t mean letting go of incentives for long-term asset building—far from it, in fact. Implementing policy supports to help Americans build flexible savings will improve prospects for long-term asset development by bolstering short-term financial security and leaving folks less vulnerable to having a personal emergency become an economic disaster.
From this perspective, it makes sense to tweak existing retirement-focused accounts so they can more readily address short-term needs. At the state level, policymakers should make the conscious policy choice to include flexible features in universal retirement savings programs that are being developed to serve the half of the workforce without access to retirement savings plans. Perhaps most significantly, policymakers should implement an explicit incentive intended to jumpstart a constructive savings process. Proposed legislation to create a Financial Security Credit would match the first $500 in deposits to savings accounts in order to get eligible families moving in the right direction.
These changes would not undermine the long-standing goals of helping families build lifetime assets like retirement savings and home equity. Instead, support for greater flexible savings will, in the long run, provide a stable and desperately-needed foundation for Americans’ financial security. Only when its foundation is secure can any house stand tall.