Nudged and Stuck
By David Henderson
Automatic enrollment appears to be a win-lose approach to changing 401(k) savings behavior. The win aspect is that automatic enrollment dramatically increases 401(k) participation, with particularly large effects among the groups who would otherwise tend to have the lowest participation rates (blacks and Hispanics, the young, and those with lower compensation). Automatic enrollment also serves to partially equalize participation differences with respect to gender, race/ ethnicity, age, and compensation. The lose aspect of automatic enrollment is that it generates a tremendous amount of participant inertia. The vast majority of plan participants stick with the default contribution rate and investment allocation, even though only a tiny fraction of participants not subject to automatic enrollment voluntarily choose that particular allocation within this company. Simulation results reported in a previous version of this paper [Madrian and Shea 2000] show that default savings behavior under automatic enrollment may actually lead to lower total 401(k) savings after only a few years relative to more traditional 401(k) plans that require an active savings decision on the part of participants. (emphasis added)
This is from Brigitte C. Madrian and Dennis F. Shea, “The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior,” Quarterly Journal of Economics, November 2011, Vol. 116, No. 4.
According to a news story in today’s Wall Street Journal, “401(k) Law Suppresses Saving for Retirement,” July 7, many people have got stuck at the suggested 3% level. Here’s the Journal:
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.”
Of course averages are almost always misleading. When you bring in a lot of people who wouldn’t have saved anything but who now save 3%, that will bring down the average of participants’ savings rates while it still could increase overall saving. Indeed, according to the Journal story:
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.