According to a PYMNTS survey last summer, 61% of Americans are living paycheck to paycheck. Experiencing even one financial emergency can throw a worker into a panic. The worker can become stressed to the max, which can impact job performance. Employers can use various ways to help employees when they face personal financial emergencies. Thinking about it now enables a company to set up policies and procedures for this purpose.
1. Salary advances
An employee may need money now and can’t wait until payday. Employers may advance cash against the next paycheck. Keep some practical and legal matters in mind:
- Comply with minimum wage rules. For example, if an employer incurs costs to make a paycheck advance and passes on the cost to the employee, the next paycheck can’t be lower than the minimum wage. Be sure to note special rules for withholding from a final paycheck; federal and state rules may vary.
- Set company policy on paycheck advances. Decide whether the company will make such advances. If so, this must be done on a nondiscriminatory basis. Set the terms of repayment (e.g., subtractions from upcoming paychecks with minimum wage rules in mind or separate repayment).
2. Personal loans
While an employer doesn’t want to act as a banker for employees, there are situations where the business may make a personal loan to an employee. Again, be sure you structure loans properly:
- Put loans in writing. A promissory note signed by the employee should include a repayment schedule, the interest rate, and what happens in default. Again, if an employee is making repayments through reductions in upcoming paychecks, minimum wage rules apply. Also cover the contingency that the employee may leave the company before full repayment; what happens then?
- Set an appropriate interest rate. A loan usually isn’t taxable, but if the rate is below the Applicable Federal Rate (AFR) for the term of the loan, it can result in taxable compensation subject to employment taxes.
3. 401(k) loans
A 401(k) plan is not required to offer participants the option of taking loans, but an estimated 90% do (and about 40% have taken advantage of this option). If the option is on the table, it must be available to all participants on a nondiscriminatory basis (i.e., it can’t be restricted to owner-employees).
Loans can be made for any reason. The participant does not have to provide a reason or have a serious financial need (as in the case of a hardship distribution described next).
A plan can set limits on the amount of borrowing, but under tax law can’t be more than the lesser of:
- The greater of $10,000 or 50% of the vested account balance
- Term of the loan: no more than 5 years (longer for borrowing to buy a home).
- Payment rate: ratably over the term of the loan, but at least quarterly. Repayment may be suspended for a leave of absence of up to one year or for military service.
- Interest: a commercially reasonable rate of interest must be charged .The IRS treats the prime rate plus 2% as a reasonable rate of interest, although this is not an official safe harbor for a commercially reasonable rate of interest. The interest is being repaid to the participant’s account, but likely is not tax deductible. The plan can charge a loan origination fee.
You can find more details about plan loans from the IRS.
4. Hardship distributions
If the company has any type of qualified retirement plan—a SEP, a profit-sharing plan, or a 401(k)—it can allow for distributions on account of a “severe and immediate financial hardship.” Events may include, for example, paying for a funeral of a spouse or college tuition of a child. The distributions cannot exceed the amount necessary to cover the need. The distributions are taxable to the employee and subject to an early distribution penalty if the employee is under age 59½. Once the distribution is taken, it cannot be recontributed.
As of January 1, 2024, employers with 401(k) plans can set up pension-linked emergency savings accounts (PLESAs), so this is the newest way for employers to help employees meet financial emergencies. As the name implies, you need a 401(k) to proceed.
- Employee perspective: Eligible employees—those who meet plan eligibility requirements and are not highly compensated—may contribute to the PLESA, which is a designated Roth account (no tax break for the contribution but not tax on a distribution). They can do this even if they don’t participate in the employer’s 401(k). In general, the maximum balance in a participant’s PLESA (attributable to contributions) is $2,500, though employers can choose to set a lower limit. Funds are held in cash in an interest-bearing account. “Highly-compensated” for 2024 means earning $150,000 or more.
- Employer perspective: Employers are not required to set up PLESAs, but may choose to do so. They can set a limit for the maximum contribution amount, but no more than $2,500. Employer’s matching contributions are made with respect to PLESA contributions at the same rate as contributions to the linked 401(k). The first 4 withdrawals from an account in the year can’t be subject to any fees or charges by the plan. The IRS and the DOL issued guidance to ensure things are working correctly.
6. Special 401(k) withdrawals
Also effective as of the start of 2024 is the option to allow a retirement plan to permit one distribution per calendar year for personal or family emergency expenses, up to the lesser of $1,000 or the vested account balance over $1,000. The withdrawals are taxable, but not subject to the 10% early distribution penalty for those under age 59½. The distribution can be recontributed within 3 years. But no additional withdrawals can be made during this period unless there’s been repayment. As yet, there’s no IRS guidance on this withdrawal option.
Employers can help employees with their personal financial emergencies by providing solutions for access to needed cash. It’s also advisable to explain the difference between these options and their impact on personal taxes, retirement savings, and their overall financial well-being.