It’s My Money and I Need it Now!
On Demand Pay Apps Address Financial Illness Symptoms – Are They The Newest “Attractive Nuisance?”1
Workers living payday-to-payday? Cash-strapped? Money problems? Unbanked, underbanked? Unexpected expenses? Damaged credit? Income shocks? Unable to cover normal, periodic, expected, everyday expenses?
Do your workers need cash now? Are you getting demands to add an on-demand pay app? Are you getting solicitations from “financial wellness” providers who argue such programs are dramatically less expensive compared to payday loans and other forms of high-cost credit – with fees of perhaps $6 a month, plus perhaps $5 per payday per use, plus interest rates of 6% to 36%.2 Providers confirm workers like this stuff, and since workers pay the full costs in most situations, why not make it available?
Such on-demand pay apps are certainly better alternatives than payday loans or incurring late fees and interest, or fees for insufficient funds due to overdrafts. But, much like payday loans, an app that enables workers to accelerate a portion of their next regular paycheck may enable continuation of suboptimal financial behavior. It may allow for chronic spending in excess of regular income.
Who wants to provide a cushion that would enable a worker to delay behavior changes that would improve financial wellness, reduce financial stress, and potentially improve productivity? Who wants workers to remain mired behind the “payday-to-payday” curve? And, if reported studies are accurate, that on-demand pay apps have reduced turnover by up to 30%, are those financially insecure workers who must rely, over and over, on this form of liquidity, really a desired group of workers?
Recent articles showed that at one firm, 85% of workers were enrolled and 70% used the pay app regularly. At another, 27% of workers were regular users. At another, 75% of workers enrolled. At another, 66% took advantage of the program. Some employers, but not all, limit the accelerated payment to 50% of net pay. The Aite Group, a research firm, said the on demand pay app industry is “poised for exponential growth”, estimating there were 18.6 million early U.S. payroll transactions totaling more than $3.15 billion in 2018.3 For example, Alight Solutions recently added a pay app.4 Those are significant amounts and a significant level of utilization.
Think about it. Much like hardship withdrawals, is an on-demand pay app beneficial to the users themselves? Is on-demand pay something you want to tout, to highlight as part of your total rewards strategy? Is the on-demand pay app an attraction and retention device?
Or is it another attractive nuisance?5
Consider this scenario: Tom earns $26,000 a year, paid biweekly, or $1,000 per paycheck. After taxes, employee contributions towards the cost of medical and dental coverage, and say 6 percent to the 401(k) plan, Tom is left with $600 in his regular paycheck. From that comes his regular living expenses, repayment of student and car loans, and any emergency requirements. If Tom is a regular user of the app, consistently accelerating $280 each payday ($300 minus about $20 in fees) to pay bills, perhaps to splurge once in a while, if Tom can’t make do from payday-to-payday, why wouldn’t Tom take other actions to increase his take home pay and provide greater access before payday, while stretching each paycheck even further:
- Reduce his federal and state income tax withholding,
- Suspend contributions to the 401(k) and Health Savings Account (foregoing the tax preferences and employer financial support), and perhaps
- Make only the minimum payment on credit cards, perhaps even stop paying on his student loan?6
So, if on-demand pay is another “attractive nuisance,” what is the alternative? What can employers/plan sponsors do?
An Alternative Solution?
When you hire someone, there is an investment – in training, onboarding, health and wellness, etc. Why not invest in financial wellness? Why not offer non-highly paid workers the opportunity to break the payday to payday living cycle once and for all time?7 Isn’t that the improvement you really want to see; improved worker productivity from reduced financial stress?
How would Tom respond if you offered:
- A written, financial contract that incorporates a commitment device that “ties Tom to a financial wellness mast,"8
- A no fee, interest free compensation loan9 equal to 4.5% of Tom’s biweekly salary for each payday during the first six months of employment,
- Automatic enrollment into the 401(k) plan, with a pre-tax deferral of 6% of pay, and say a 100% vested employer matching contribution of 3% of pay,
- No cost financial wellness counselling on paying bills and budgeting during the first 12 months of employment,
- Elimination of hardship withdrawal provisions, plus
- 21st Century liquidity provisions for 401(k) loans, using a line-of-credit structure, allowing for maximum borrowing.
Assuming a 5% rate of return, after six months, Tom will have a 401(k) account balance equal to $1,200, and an outstanding compensation loan of $585.
Then, Tom’s 401(k) account becomes the “Bank of Tom.” From this point forward, Tom borrows from his 401(k) account as necessary to retire outstanding debts and to break the cycle of living payday-to-payday. Plan loans have a term of five years (perhaps adding to retention) while loan payments must be made no less frequently than quarterly to meet the level amortization requirements (however, a cure period can be applied).10 During the next six months, Tom would continue contributions to the 401(k) plan (again, borrowing from the 401(k) to eliminate debts and the associated bills) so he can maintain his standard of living while further building his account. Then, 12 months after hire, Tom would have a 401(k) account balance estimated to be $2,464.
Tom would then borrow from the 401(k) account to repay the compensation loan. The cost to the employer for the $585 loaned to Tom during his first six months of employment? Less than $50 (assuming foregone interest at 5%, author’s calculations) plus the cost to process transactions and provide financial wellness counseling.
If you have employees who live payday-to-payday, who are financially stressed and who continue suboptimal financial behaviors, can you afford to forego making that investment?
1J. G. Wentworth, https://www.youtube.com/watch?v=HX0fIi3H-es&app=desktop
2Anne Tergesen, Some Companies Offer a New Benefit: Payroll Advances and Loans: Employers aim to improve productivity, lower attrition via services for cash-strapped workers, Wall Street Journal, 9/2/19, Accessed 9/5/19 at: https://www.wsj.com/articles/some-companies-offer-a-new-benefit-payroll-... See also: J. Ramirez, Why on-demand pay is in demand, 8/9/19, Accessed 9/5/19 at: http://hrexecutive.com/why-on-demand-pay-is-in-demand/ But see: Y. Hayashi, Pay-Access Apps Face Regulatory Test, Wall Street Journal, 9/2/19. “… Last month, regulators from New York and 10 other states said they were investigating whether some payroll-advance firms violated payday-lending laws. … “This investigation will help determine whether these payroll-advance practices are usurious and harming consumers,” said Linda Lacewell, New York’s chief financial regulator. She added that some of the firms “appear to collect usurious or otherwise unlawful interest rates disguised as tips, monthly memberships” and other fees.” … The pay-access apps, particularly those dealing directly with consumers, have similarities to payday loans, including a basic feature where the consumers receive payment in exchange for information about their bank-account, from which payments are later automatically collected. Unlike payday lenders, however, pay-access providers have no recourse, meaning if their customers fail to pay back the money, the companies can’t go after them and file collection lawsuits. The payments also can’t be rolled over for more fees either, a feature that makes payday loans costly for many consumers.” Accessed 9/5/19 at: https://www.wsj.com/articles/pay-access-apps-face-regulatory-test-115674...
3L. Parrish, Employer-Based Loans and Early Pay: Disruption Reaching Scale, Vendors enabling employer-based installment loans and early access to earned wages are poised for growth. 4/5/19, Accessed 9/5/19 at: https://www.aitegroup.com/report/employer-based-loans-and-early-pay-disr...
4E. Nedlund, DailyPay, Alight Solutions partner to offer employees early access to their pay, Employee Benefit News, September 2019. “
5J. Towarnicky, Hardship Withdrawals – An Attractive Nuisance Becomes More Attractive, 2/9/18, Accessed 9/5/19 at: https://www.psca.org/blog_jack_2018_5 See also: Cold Turkey Withdrawal, 11/26/18, Accessed 9/5/19 at: https://www.psca.org/blog_jack_2018_53
6A. Tanzi, U.S. Student Debt in ‘Serious Delinquency’ Tops $166 Billion, Bloomberg, 2/16/19. That amount is about 11% of all outstanding student loan debt. Accessed 9/5/19 at: https://www.bloomberg.com/news/articles/2019-02-16/u-s-student-debt-in-s...
7J. Towarnicky, It is Not Borrow to Save, But Save to Borrow! 10/9/18, Accessed 9/5/19 at: https://www.psca.org/blog_jack_2018_45 See also: The “Elephant” In the Retirement Savings Room, 8/5/19, Accessed 9/5/19 at: https://www.psca.org/blog_jack_2019_44 See also: Financial Wellness Via Your 401(k), 11/7/17, Accessed 9/5/19 at: https://www.psca.org/blog_jack_2017_15
8The classic example of a commitment device and perhaps the first known use was the tale of Odysseus ordering his men to lash his body to the mast of the ship so he would be able to hear the sirens' song without jumping overboard. Odysseus' choice to be tied to the mast of the ship is his 'present' choice. That choice restricted his future choices, preventing him from impulsively jumping overboard. By using a commitment device, Odysseus was able to achieve his goal of hearing and enjoying the sirens' song without jumping ship, a decision that would not have been in his long-term self-interest.
9Internal Revenue Code Section 7872 (IRC §7872).
10Repayment of the loan must occur within 5 years, and payments must be made in substantially equal payments that include principal and interest and that are paid at least quarterly. However, the plan administrator may allow a cure period where the installment payment is paid no later than the last day of the calendar quarter following the calendar quarter in which the required installment payment was due. Treasury Regulation §1.72(p)-1, Q&A-3, Q&A 10