Employers are increasingly putting workers’ 401(k) plan savings on autopilot. But the positive impact of automated retirement savings is more muted than initially thought, new research finds.
Previously “underexamined” factors — like workers cashing out 401(k) balances when they leave a job — “meaningfully reduce” the long-term impact of policies like automatic enrollment and automatic escalation, according to a new paper published by the National Bureau of Economic Research.
The study, conducted by behavioral economists James Choi of Yale University, and David Laibson and John Beshears of Harvard University, sheds light on the challenges that arise with automated retirement savings programs. These economists are considered pioneers in the field and have been studying the effects of automatic enrollment for decades.
Automated savings has been a cornerstone of 401(k) policy since Congress passed the Pension Protection Act of 2006. Policies like auto-enrollment and auto-escalation aim to boost the size of employees’ nest eggs by automatically enrolling workers in their company 401(k) and then raising their savings rate over time. This approach leverages people’s tendency towards inertia to help them save more effectively for retirement.
About two-thirds of 401(k) plans were using auto-enrollment as of 2022, according to survey data from the Plan Sponsor Council of America, with 78% of them also implementing auto-escalation. While these programs have a positive effect on savings, the recent research indicates that their impact may not be as significant as previously believed.
The study found that auto-enrollment raised average 401(k) contribution rates by 0.6 percentage points of income over workers’ careers. This represents a 72% decrease in effectiveness compared to earlier estimates, highlighting the need for a more nuanced understanding of the factors influencing retirement savings behaviors.
One of the key challenges identified in the research is the issue of “leakage” from 401(k) plans, which refers to the early withdrawal of funds before retirement. About 40% of workers who leave a job cash out their 401(k) plans each year, according to the Employee Benefit Research Institute. This leakage amounted to $92.4 billion in 2015, underscoring the significant impact it has on retirement savings.
Workers who withdraw funds from their 401(k) plans before their employer match is fully vested may miss out on valuable free money. Additionally, the study found that only 43% of workers defaulted into auto-escalation ultimately accepted a higher contribution rate after one year, highlighting the challenges of sustaining increased savings rates over time.
Job turnover also complicates auto-escalation, as a worker’s escalated contribution rate may reset at a lower savings rate if they join a new employer’s 401(k) plan. This turnover can disrupt the progress made through auto-enrollment and auto-escalation, making it harder for workers to build substantial retirement savings.
While auto-enrollment has proven to be successful in getting individuals to start saving for retirement, there is still room for improvement in addressing the leakage issue and sustaining increased savings rates over time. Behavioral economist David Blanchett of PGIM believes that auto-enrollment does a remarkable job of getting workers into the plan but acknowledges the challenges posed by leakage.
Blanchett suggests that setting a higher default savings rate, such as 7% or 8%, could help workers save more effectively for retirement. When coupled with an employer match, this higher default rate could result in workers saving 10% or more of their salaries, a level that is generally recommended for retirement preparedness.
Ultimately, the study’s findings underscore the importance of a comprehensive approach to retirement savings that addresses the complexities of human behavior and financial decision-making. By understanding the factors that influence savings behaviors, employers and policymakers can design more effective retirement savings programs that help workers build secure financial futures.
Implications for Retirement Savings Policies
The research on the effectiveness of 401(k) auto-enrollment and auto-escalation programs has significant implications for retirement savings policies. While these programs have been widely adopted by employers as a way to boost workers’ savings rates, the study’s findings suggest that their impact may not be as substantial as previously believed.
One of the key challenges identified in the research is the issue of leakage from 401(k) plans. Workers who cash out their 401(k) balances when they leave a job not only miss out on valuable savings but also disrupt the progress made through auto-enrollment and auto-escalation programs.
To address this challenge, policymakers may need to consider implementing measures that discourage early withdrawals from 401(k) plans and promote long-term savings behavior among workers. This could include providing financial incentives for maintaining retirement savings accounts or implementing penalties for early withdrawals.
Additionally, the study’s findings highlight the importance of sustained engagement and communication with workers to ensure that they understand the benefits of saving for retirement. By providing clear information about the long-term impact of retirement savings programs and offering resources to help workers make informed decisions, employers can help employees build more secure financial futures.
Future Directions for Retirement Savings Research
The research on 401(k) auto-enrollment and auto-escalation programs opens up new avenues for future research on retirement savings behavior. By identifying the challenges and limitations of these programs, researchers can develop more effective strategies for promoting long-term savings among workers.
One potential area for further study is the impact of financial education and literacy programs on retirement savings behavior. By providing workers with the knowledge and skills they need to make informed financial decisions, employers can help them better understand the benefits of saving for retirement and the consequences of early withdrawals from 401(k) plans.
Another area for future research is the role of employer matching contributions in promoting retirement savings. By examining the impact of employer matches on workers’ savings behavior, researchers can identify ways to maximize the benefits of these contributions and encourage workers to save more for retirement.
Overall, the study’s findings underscore the need for a holistic approach to retirement savings that takes into account the complexities of human behavior and financial decision-making. By addressing the challenges identified in the research and developing more effective strategies for promoting long-term savings behavior, employers and policymakers can help workers build secure financial futures for retirement.