401(k) Nudges and Course Corrections
Behavioral economist Richard Thaler, winner of the 2017 Nobel Prize for economics, regards his field’s greatest contribution as showing that people are more likely to save if the saving happens automatically.
“I’m all for empowerment and education, but the empirical evidence is that it doesn’t work,” he said in a 2015 Wall Street Journal interview. “That’s why I say make it easy.”
To make saving for retirement easier, employers have increasingly turned to automated 401(k)s. Automation has taken two basic forms. The first, automatically enrolling each employee, is pervasive and has had notable success in increasing participation in retirement savings plans. The second form, automatically increasing the amount employees save – a concept originated by Thaler and economist Shlomo Benartzi – is catching on. It’s hoped that the second will correct a problem created by the first.
Last year, 45 percent of Vanguard’s client base used auto-enrollment plans, according to its “How America Saves 2017” report. Historically, employees were asked to enroll in their employer’s 401(k). Today, more employers are – as Thaler would say – “nudging” workers by automatic enrolling them, usually when they are hired. Although they then have the freedom to opt out, inertia tends to keep them in the plans.
Participation in all types of 401(k)s has roughly increased in lock-step with the spread of auto-enrollment. Last year, 79 percent of workers participated in Vanguard-administered plans, up from 68 percent a decade ago, when a new federal pension law made auto-enrollment more appealing to employers.
The irony, however, is that while auto-enrollment encourages more people to save, Vanguard partly blamed a 2016 drop in employee contributions on their popularity. The average employee contribution in all types of 401(k) plans declined from 6.9 percent of 2015 pay to 6.2 last year, well below the 7.3 percent rate prior to the Great Recession, according to Vanguard.
The reason is that employees often will stick with the relatively low contribution rate set by their employer – again, employee inertia’s at play. Well-known research studies back this up. The default contribution rate in auto-enrollment plans is usually just 3 percent to 4 percent of pay.
Most regular Americans probably need to save more for retirement, especially if they haven’t consistently been saving throughout their working lives. This is where that second, newer twist on automation comes in: auto-enrollment plans are instituting annual, automatic increases in employees’ saving.
Increasing contribution rates and higher default contribution rates in auto-enrollment plans helped to increase average contributions in these plans to 6.1 percent of pay last year, up from just 4 percent in 2009, Vanguard said. Last year’s rate is nearly the same level as the saving rate for both automatic and voluntary 401(k) plans combined.
Thaler’s take on auto-enrollment and auto-escalation is that you gotta have both to achieve retirement security.
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