Behavioral Public Finance

Chapter 11. Saving for Retirement on the Path of Least Resistance

Chapter 11 Saving for Retirement on the Path of Least Resistance JAMES J. CHOI, DAVID LAIBSON, BRIGITTE C. MADRIAN, AND ANDREW METRICK O ver the last twenty years, defined contribution pension plans have gradually replaced defined benefit pension plans as the primary privately sponsored vehicle for retirement income. At yearend 2000, employers sponsored over 325,000 401(k) plans with more than forty-two million active participants and $1.8 trillion in assets.1 The growth of 401(k)-type savings plans and the associated displacement of defined benefit plans have generated new concerns about the adequacy of employee savings. Defined contribution pension plans place the burden of ensuring adequate retirement savings squarely on the backs of individual employees. However, employers make many decisions about the design of 401(k) plans that can either facilitate or hinder their employees’ retirement savings prospects. Although the government places some limits on how companies can structure the plans, employers nonetheless have broad discretion in their design. Good plan design decisions require understanding the relationship between plan rules and participant choices. Here we analyze a new data set that enables us to carefully assess many such relationships. It is compiled from anonymous administrative records of several large firms that collectively employ almost 400,000 individuals. Many of these companies implemented changes in the design of their 401(k) plans. These plan changes enable us to evaluate the impact on individual savings behavior of institutional variation in 401(k) plan rules. A list of the companies we study, along with the plan changes or other interventions that we analyze , appears in table 11.1.2 304 Table 11.1 Company 401(k) Plan Changes or Other Interventions Company Industry Sizea Plan Change or Intervention Date of Change or Intervention A Food 10,000 Savings survey January 2001 B Office equipment 30,000 Adopted automatic enrollment January 1997 Eliminated automatic enrollment January 2001 C Insurance 30,000 Adopted automatic enrollment April 1998 Financial education seminars January to December 2000 Changed automatic May 2001 enrollment defaults D Food 20,000 Adopted automatic enrollment January 1998 Increased default contribution rate January 2001 E Utility 10,000 Increased match threshold January 1997 F Consumer packaged goods 40,000 Changed eligibility July 1998 Instituted employer match October 2000 G Insurance 50,000 Changed eligibility January 1997 H Manufacturing Adopted automatic enrollment January 2001 I Retail 130,000 None NA J Financial Services 50,000 None NA K Pharmaceutical 10,000 Changed eligibility January 1996 Source: Authors’ calculations. a Number of employees (rounded to the nearest 10,000) on December 31, 1998 (company K), December 31, 2000 (Companies A, B, D, E, F, G, I, and J), June 30, 2000 (company C) or December 31, 2001 (company H). 306 Behavioral Public Finance Low employee savings rates have motivated plan administrators to adopt many of the 401(k) plan changes that we discuss throughout the chapter. Using new data from a survey we designed, we find that twothirds of employees believe that they are saving too little and that onethird of these self-reported under-savers intend to raise their savings rate in the next two months. By matching survey responses to administrative records, we show that employees who report that they save too little actually do have low 401(k) saving rates. However, almost none of the employees who report that they intend to raise their savings rate in the next two months actually subsequently do so. This finding introduces a theme we return to throughout this chapter: at any point, employees are likely to do whatever requires the least current effort. This phenomenon—which we call passive decision making— implies that employers have a great deal of influence over the savings outcomes of their employees. Employer choices of default savings rates and default investment funds, for example, strongly influence employee savings levels. Even though employees have the opportunity to opt out of such defaults, many never do so. Employers and policy makers need to recognize that there is no such thing as a neutral menu of options for a 401(k) plan. Framing effects will influence employee choices, and passive employee decision making implies that the default options will often carry the day. Sophisticated employers will choose these defaults carefully, keeping the interests of both employees and shareholders in mind. Savings Adequacy In January 2001, we administered a...