A recent study by Boston College's Center for Retirement Research might not exactly be the New Year's news that plan sponsors and plan administrators are looking for: Simply nudging people into more vested 401(k) participation through a high default deferral rate may do very little to increase overall financial participation in the plans.
The research, "A Nudge Isn't Always Enough," suggests that setting a particularly high default rate for new participants in a workplace 401(k) plan may in fact produce the very opposite effect, with participants immediately opting for a lower deferral.
The whole strategy, the project's authors report, boils down to some basic elements of behavioral theory and behavioral economics – what can be done to compel workers to take action and save their own money, without actually forcing them to do so.
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Conventional wisdom suggests that those mild nudges – plan designs which offer automatic enrollment and automatic escalation, unless participants take the action to opt out on their own – do tend to provide better overall participation rates, just as the same strategies work in decision-based strategies from organ donations to online marketing.
Given the early success of auto-enrollment, legislation was drafted in the Pension Protection Act of 2006 to further encourage the strategy, and some 45 percent of 401(k) plans in the country now offer it for new hires.
But there's a downside to automating participant choices, especially when it comes to a higher-than-comfortable deferral rate. The study cites the case of a British-based company which set a 12 percent deferral rate as the automatic starting point for its retirement plan; more than 75 percent of the employees chose to opt out of that rate.
The same was found in an experimental project that hoped to get low-income earners to immediately set aside their tax refunds into a formalized retirement savings plan. When H&R Block offered to match its clients' tax refunds for purposes of investing in an IRA, the results were somewhat positive, though they did not create massive changes; a similar program to encourage low-income earners to purchase U.S. Savings Bonds with their refunds got only a 6 percent response.
A more recent program making it easy for low-income earners to instantly funnel their refunds into a bonds program – complete with plenty of in-office advertising of the benefits of participating in the Savings Bonds – uncovered similar results.
In fact, even though a control group was given material that didn't even make the purchase of bonds a yes-or-no decision, but instead assumed they would take part, it had almost no effect whatsoever. Only 9 percent of the tax filers bought bonds, whether they were "nudged" or not.
Researchers suggested that the failure of these experiments came because low-income earners had generally planned to spend any money they received as a tax refund, and were not particularly interested in savings.
Those new hires who are automatically enrolled in a 401(k) program might show slightly better results and could be more apt to take a healthy deferral rate as 401(k)s in general coincide with employees pre-existing intentions to save for retirement.
Their conclusion? The success of default design seems to depend on the group demographics involved, meaning it might be more appropriate (and successful) in an employer-based 401(k) offering than a push aimed at tax filers who've already pre-spent the money in their own minds.
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