Designing retirement plan default options

One of the big successes of behavioral economics has been in disseminating that decision making and information gathering are costly, so that default options matter. The WSJ seems to have taken the empirical lesson of behavioral economics to heart (even if not always on its editorial page) and reports a study of the effects of default settings.

401(k) Law Suppresses Saving for Retirement

"A 2006 law designed to boost employees' retirement-savings is having the opposite effect for some people.
"Under the law, companies are allowed to automatically enroll workers in their 401(k) plans, rather than require employees to sign up on their own. The measure was intended to encourage more people to bulk up their retirement nest eggs—a key goal in a country where millions of people aren't saving enough.

But an analysis done for The Wall Street Journal shows about 40% of new hires at companies with automatic enrollments are socking away less money than they would if left to enroll voluntarily, the Employee Benefit Research Institute found. The nonprofit performed a complex computer simulation of savings patterns drawing on data from more than 20 million 401(k) participants.

The problem: More than two-thirds of companies set contribution rates at 3% of salary or less, unless an employee chooses otherwise. That's far below the 5% to 10% rates participants typically elect when left to their own devices, the researchers said.

"Automatic enrollment is a double-edged sword," said Brigitte Madrian, a professor at Harvard University who is an expert on 401(k)s. "On the one hand, there's more participation. On the other hand, lots of employees are stuck at whatever default the employer selects.

""The total annual amount being put into 401(k) plans has increased by 13% since 2006, to an estimated $284.5 billion this year, according to consulting firm Cerulli Associates. That is largely because the rule has successfully prodded millions of people who wouldn't have saved a penny for retirement to start saving something.

"But for the 40% of new workers who would have picked a higher savings rate than the company assigned to them, billions of dollars in potential retirement savings will be left on the table, said Pamela Hess, director of retirement research at Aon Hewitt. The human-resources consulting and outsourcing company serves as a record-keeper for $296.8 billion in 401(k) plans.
...
"The Pension Protection Act of 2006, which was designed to shore up the pension system, also encouraged wider adoption of auto-enrollment in 401(k) plans. It removed obstacles such as state laws that restricted the practice and shielded employers who use certain types of investments from liability for losses suffered by participants who are auto-enrolled.

"The law has boosted auto-enrollment and participation rates dramatically. About 57% of large companies now automatically enroll new employees in 401(k) plans, up from 24% in 2006, according to Aon Hewitt. While employees are free to opt out, companies report average participation rates above 85%, compared with 67% for those without auto-enrollment, Aon Hewitt says.

"Yet 401(k) participants' average savings rates have fallen in recent years. Among plans Aon Hewitt administers, the average contribution rate declined to 7.3% in 2010, from 7.9% in 2006. The Vanguard Group Inc. says average contribution rates at its plans fell to 6.8% in 2010, from 7.3% in 2006. Over the same period, the average for Fidelity Investments' defined contribution plans decreased to 8.2%, from 8.9%.

"Vanguard estimates>about half the decline "was attributable to increased adoption of auto-enrollment."
...
"Many companies said they selected a 3% default contribution rate in part out of concern that a higher rate could prompt employees to drop out of these plans.Medtronic Inc. spokeswoman Cindy Resman said the medical-device maker opted for a 3% contribution rate because that was the prevailing rate in 2007, when the company implemented auto-enrollment."