At the beginning of every school year, the Teacher’s Association at Anna Chandler’s school collects money for the “Sunshine Fund.” Teachers pool their money. They use the proceeds to celebrate when colleagues get married or have a new baby. Other times, they buy cards or flowers for bereaving colleagues or those who are sick.
Most teachers aren’t selfish. But as Anna says, “Many people didn’t buy into the Sunshine Fund. When the forms were sent out, at the beginning of the year, a smaller than expected number of the teachers chose to enroll.”
The Teacher’s Association decided to try something different. Instead of giving the teachers the choice of opting in to the Sunshine Fund, they enrolled them automatically. They could opt out if they wanted. But few of the teachers did.
Employers are using the same strategy with their company 401(k) plans. That’s a good thing. Social Security is like a 35 year-old professional football player. It might still be scoring touchdowns. But its future looks less rosy.
That’s why Americans need to save. Sheldon Garon is professor of history and East Asian studies at Princeton. He’s also the author of
Beyond Our Means: Why America Spends While the World Saves. He says Continental Europeans and East Asians save more money than Americans. U.S. participation rates in company 401(k) plans are also lower than we might think.
Bloomberg’s Ben Steverman reports that two-thirds of Americans aren’t contributing to their company’s 401(k). That’s based on data from the U.S. Consensus Bureau. It uses tax data, which is likely much more reliable than surveys.
But here’s the good news. Companies that enroll employees automatically see higher 401(k) participation rates.
Professors Brigitte Madrian and Dennis Shea published The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior for The National Bureau of Economic Research. They examined 401(k) participation rates for new employees in a large U.S. company. The employees received a 50 percent match for money they contributed, up to a total of 6 percent of their salary. In other words, if an employee earned a salary of $50,000 per year, she could earn $1,500 of free money if she contributed $3000 to her company 401(k).
But free money, itself, wasn’t a strong incentive. New employee participation rates were just 20 percent after 3 months of employment. That number increased to 65 percent after 36 months. But when new employees had to opt-out of the 401(k) instead of opting-in, participation rates jumped to 98 percent after just 6 months.
Researchers Richard H. Thaler and Cass R. Sunstein wrote the New York Times Bestseller, Nudge: Improving Decisions About Health, Wealth And Happiness. They say people don’t refuse free money on purpose. They’re just busy. Filling out forms isn’t fun. Sometimes, the forms are complicated and overwhelming.
The authors referenced a mind-blowing example. David Blake is a Professor of Pension Economics at London’s Cass Business School. He’s also the Director of the Pensions Institute. Blake studied twenty-five UK-based defined benefit pension plans. In each case, employees didn’t have to contribute money. The employer did it for them. The pensions offered retirement money for life if employees signed up to the plan. But here’s the crazy part. Fifty-one percent of the employees didn’t sign up.
That’s why Richard H. Thaler and Shlomo Benartzi recommend that businesses automatically enroll their employees in 401(k) plans. They also introduced a program called, Save More Tomorrow. Here’s what they learned. If they educated employees on the importance of saving more money, it did little to boost savings. But if the employer simply took more money out of their monthly pay, each time the worker earned a raise, it dramatically boosted savings rates.
The researchers first experimented with a mid-sized manufacturing firm in 1998. They focused on workers who said they couldn’t afford to increase their annual 401(k) contributions. A consultant for the company asked if they would be interested in joining a plan that would increase their savings rates by 3 percent every time they got a raise. Seventy-eight percent of them agreed. Each time they earned a raise, the company put part of the workers’ increased pay into their 401(k).
Before the program began, these employees were saving just 3.5 percent of their income. After three and a half years (and four pay raises) they had almost quadrupled their savings to 13.6 percent of their income.
In 2015, The Wall Street Journal’s Kirsten Grind wrote, Companies To Workers: Start Saving More Or We’ll Do It For You. She says companies from Apache Corp. to Google to Credit Suisse Group have initiated the Save More Tomorrow approach. Employers increase 401(k) contributions by 1 percent per year, unless employees opt out. But they rarely refuse. That’s why they end up saving a lot more money.
Some states are also encouraging automatically enrolled savings plans. Bloomberg reports that California, Oregon, Illinois, Maryland, and Connecticut are trying to help workers save more money. They want employers in those states to offer a retirement plan, or automatically enroll their workers in a state-sponsored individual retirement account.
The Obama administration gave the thumbs up. But on February 15, 2017, the U.S. House of Representatives voted to cancel it. They said auto-enrollment plans weren’t fair to the financial services industry because it doesn’t encourage fair competition among investment providers.
That might be true. But I hope the administration finds some effective, common ground. After all, employers have finally found a way to help people save more money. That might not benefit every financial firm. But it does help the people, which I think is more important.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.