Mimi Lord, TIAA-CREF Institute
June 2006 |
In recent years, a number of academic researchers have conducted analyses of retirement plan designs to better understand features that promote greater participation and contribution rates. Renowned experts in behavioral finance have linked low participation and savings rates in defined contribution (DC) plans to such human behaviors as procrastination and inertia, which has been described as “the divergence between desire and effective action.” With regards to saving for retirement, many workers simply don’t get around to enrolling in their employer’s retirement plan. Others, once they enroll and decide on an initial contribution rate, never take further steps to increase their contribution rates. And, in many instances where employers provide matching contributions, employees leave substantial amounts of free money on the table.
Researchers have examined such plan features as the employer match, the number and range of investment options, and loan availability to find out their impact on employee savings behavior. While there are links between these features and employee savings, they are not nearly as significant as the impact of automatic enrollment with automatic contribution rates. Automatic enrollment and contributions address the behavioral obstacles head-on as new employees automatically begin to reap the benefits of plan participation. Automatic enrollment may also be implemented for existing employees who have never enrolled. Although employees may choose to opt out of the plan, only a very small percentage tends to do so.
Another innovation that is proving to have powerful results on savings is automatic escalation in employee contribution rates. In their TIAA-CREF Samuelson Award-winning research, Richard Thaler of the University of Chicago and Shlomo Benartzi of UCLA documented enormous improvements in savings following the implementation of pre-selected annual increases in employee contribution rates. With an automatic contribution escalator, the behavioral tendency toward inertia begins to work in the employee’s favor. By doing nothing, he/she automatically adopts higher savings rates over time.
This paper provides a survey of academic research that explores the impact of certain plan features that lead to greater participation and contribution rates, and, ultimately, to greater financial security in retirement. Through the design of their DC plans, employers play a critical role in assisting their employees accumulate retirement assets. By understanding the relationship between plan design and observed savings outcomes, employers can alter their plans to help achieve desired results. After a brief overview of studies that have examined how a variety of plan features tend to affect participation and contribution rates, the essay will discuss in more depth the very powerful impact of automatic enrollment and contribution escalators.