Here’s a trivia question you might get wrong based on the flurry of media articles on the follies of 401(k) plans we’ve seen this summer: What’s the biggest problem with 401(k) plans? Based on what we’ve seen in both the professional and the popular press, you might think the answer is “fees.”
For all the spilled ink and popped pixels, fees are not the biggest concern many “in the know” folks have with 401(k) plans. It’s also not the lack of an annuity option, unless, of course, you happen to make a living selling annuity options. For that matter, it’s not poor investment decisions (although we certainly do have a fair share of those).
No, the single most important issue facing 401(k) plans is quite simple: Employees don’t save enough.
And here’s the traditional solution 401(k) plan sponsors use to address this problem: they offer to match employee contributions. After all, who can turn their nose on free money? Well, it turns out academic studies show they do. In fact, a recent white reveals behavioral finance techniques have proven more effective (and cheaper) than the traditional match (see “7 Low or No-Cost Ways to Increase 401(k) Participation"). Let’s take a look at three of them here.
1) Increase the threshold, not the match. The “threshold” is the number where the match maxes out. For example, a plan might offer to match $0.50 for every dollar of contribution up to 4 percent of an employee’s salary. In this case, the threshold is that 4 percent. Here’s the crazy thing about employees: When they decide how much of their salary to contribute, most of them tend to pick percentages that are multiples of 5 percent (i.e., 5 percent, 10 percent, 15 percent). But here’s another thing they do even more often: They pick the threshold percentage (after all, beyond that, they get no free money). Studies show, if you keep the total matching dollars the same but increase the threshold, people will save more (up to the new threshold). Ironically, if a plan sponsor merely increases the match, employees who prior to the increase saved more than the threshold will actually cut back (because they mentally subtract the employers increased match from their previous contribution rate to maintain the same contribution rate). In our example, if the employer changes the matching policy to $0.25 for every dollar of contribution up to 8 percent, more employees will save more even though the total matching dollars remain the same.
2) Simplify the process. Behavioral psychology has long shown, when presented with difficult or complex decisions, most people just take the easy way out – they simply decide not to decide. In the specific case of 401(k) plans, believe or not most employees DO want to save. They fail to pull the switch, though, because they have to make too many decisions as part of the opt-in process or they can’t take instant action. Plan sponsors can simplify the process in two ways: First, they can stream-line their options menu by reducing choices. Second, they can provide sign-up materials via computer terminals, tablets or paper forms right in the room during the usual employee group presentation meetings.
3) Provide savings reminders early and often. When an employee gets a raise or bonus, give them a form to increase their 401(k) contributions. (I can attest from personal experience this works. In salad days of earning huge bonus, I would regularly instruct HR to divert most of the bonus to my 401(k) plan.) But it actually gets more intrusive than this. Studies show sending text messages reminding people to save more will generate greater savings. When an employee pays off a loan, suggest to that employee to keep paying that loan amount into their 401(k) plan. In essence, bug the snot out of them.
There you have it. Plan sponsors of 401(k) plans can use the power of psychology to help people help themselves. After all, it’s not a trick if it’s good for you.