7 Low or No-Cost Ways to Increase 401k Participation
Sometimes something screaming “can’t miss” on paper just doesn’t measure up when tried in the real life. The elegantly logical and precise formulae of economics often fall victim to the irrational world. But this story isn’t about investment, the usual whipping boy when it comes to the myth of rational behavior, but a simple technique many 401k plan sponsors believe – falsely, it turns out – is guaranteed to help employees improve their retirement. Since the beginning of the 401k era, plan sponsors have been told the best way to increase employee participation is to offer to match employee contributions.
Unfortunately, three decades of experience shows us, for all that matching, too many employees continue to not save enough. Indeed, many feel getting employees to save more – not getting them to invest correctly – represents the biggest problem in the 401k environment. So, how should 401k plan sponsors address this need?
As long-time readers may remember, (“New Study Explains Why the 401k Match FAILs,” FiduciaryNews.com, November 16, 2010), the myth of the supremacy of the 401k match was first revealed many years ago. “The evidence on the relative effectiveness of matching compared to other approaches to changing savings behavior has emerged over the past 10 years,” says Brigitte Madrian, the Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School in Cambridge, Massachusetts. But don’t throw out matching just yet. As the professor explains, “It is not the case that financial incentives have no effect on savings outcomes, just that effects are fairly modest.
Before coming to Harvard in 2006, Dr. Madrian was on the Faculty at the University of Pennsylvania Wharton School (2003-2006), the University of Chicago Graduate School of Business (1995-2003) and the Harvard University Economics Department (1993-1995). She is also a research associate and co-director of the Household Finance working group at the National Bureau of Economic Research, and co-editor of the Journal of Human Resources and her current research focuses on household saving and investment behavior. Her work in this area has impacted the design of employer-sponsored savings plans in the U.S. and has influenced pension reform legislation both in the U.S. and abroad.
This month Dr. Madrian published “Matching Contributions and Savings Outcomes: A Behavioral Economics Perspective” through the National Bureau of Economic Research Working Paper Series. Her paper summarized the various “401k matching” research that has occurred over the last twenty years. The paper concludes that matching fails “to incorporate the many psychological frictions that impede savings, including present bias, complexity, inattention and temptation.” Furthermore, she states “countering these frictions leads to increases in saving plan participation and asset accumulation that surpass the effects of a typical matching contribution, potentially at a lower cost.”
More importantly, the paper suggests seven practical actions 401k plan sponsors can take right now to increase employee savings that add little or no cost to the plan sponsor. We ask Dr. Madrian to explain these to our readers.
Suggestion #1: Increase the Threshold. As Dr. Madrian explains, “In a 401k plan, the ‘threshold’ is the limit at which contributions are matched. For example, if an employer provided a 50% match on contributions up to 6% of pay, the match threshold of the plan is 6% of pay (i.e., contributions above that threshold are no longer matched). The threshold serves as a focal point in making savings decisions. In most 401k plans, a sizable fraction of the participants contribute exactly at the match threshold. Increasing the threshold is one effective way to increase the amount that individuals save.” What’s more, this doesn’t mean, for example extending the 50% match from 6% to 12%. Studies indicate plan sponsors can expect increased savings rates if the match is changed from 50% of the first 6% of salary to 25% of the first 12% of salary. This latter matching formula would cost the plan sponsor no more than the first matching formula, but will likely result in employees saving more.
Suggestion #2: Automatic Enrollment. This option has only been available to American 401k plans since the 2006 Pension Protection Act, albeit with certain restrictions on investment options. Dr. Madian says “Automatic enrollment has the potential to dramatically increase savings plan participation rates, especially for demographic groups who are less inclined to save: younger employees, lower income employees and black and Hispanic employees. Most companies with automatic enrollment see savings plan participation rates of at least 80% or higher, and many see 90% or higher for affected employees.” Unfortunately, automatic enrollment seems more of a large company policy. “More than half of large companies have adopted automatic enrollment in the past several years, although smaller firms have been much slower to sign on,” says Dr. Madrian. She believes small firms, with fewer or no employees dedicated to retirement plan functions, may simply not be aware of automatic enrollment. She also thinks “much of the reluctance to adopt automatic enrollment has centered around whether the policy is too paternalistic.” Others in the industry cite the fear and confusion centered around target date funds, one of the qualified investment options plan sponsors must choose from when they adopt automatic enrollment.
Suggestion #3: Simplification. This is sort of a twist on automatic enrollment. Dr. Madrian says, “‘Quick Enrollment’ is a simplified approach to allowing employees to sign up for their employer’s savings plan. It gives employees a pre-selected contribution rate and asset allocation they can choose with a simple check of a box. Most employees want to participate in their employer’s savings plan but aren’t sure what type of investment allocation they should choose. When they have to choose an investment allocation in order to participate, they procrastinate and end up not saving at all. Approaches like automatic enrollment and Quick Enrollment work well to increase savings plan participation because they eliminate the need to deliberate over how to invest in order to start participating in the savings plan.”
Suggestion #4: Intervention-based education. When it comes to employee education, the standard is to bring a professional who then “lectures” a group of employees. Prior to last year’s DOL Rule on participant level investment advice, plan sponsors have been reluctant to engage professionals to offer one-on-one sessions with employees. From a cost standpoint, this may still not be the standard. Intervention-based education, however, doesn’t require investment advice. It only acts as a hand-holding activity to help guide employees through the 401k process. Dr. Madian explains, “In the context of employer sponsored financial education, the single most effective thing an employer could do would be to provide a mechanism to make savings plan changes before the employee walks out of the room, either enrollment or contribution rate change forms at the back of the room, or computer terminals or tablets that participants can use while they are sitting there. Once people leave, it’s out-of-sight-out-of-mind. Of course, some people may need more information to make an informed decision. For example, they might want to coordinate their savings decisions with their spouse. Research shows that simply providing employees with a short planning guide that breaks down savings plan enrollment into several small steps, tells employees how long each step will take and gives tips for how to think about the choices that need to be made, is very cost effective at increasing savings plan participation. It’s another way to think about simplifying the enrollment process.”
Suggestion #5: Provide Savings Reminders. When employers can’t afford to outfit their training rooms with computers or can’t find an appropriate app for the computers they do have, try using the cell phone – to text employees with gentle reminders. “Simply coming back to employees again and again can be an effective strategy for getting people to make active savings choices,” says Dr. Madrian. “For example, my research shows that if you send a Quick Enrollment card to non-participating employees, about 10% will fill out the card and send it in. But if you do it again a year later, another 10% will fill out the card. After three years, you can easily double the fraction of non-participants who sign up to save simply by going back to them repeatedly.” She urges 401k plan sponsors to think creatively by using already existing activities to encourage participation. “For example,” she says, “each year when a company has open enrollment for their health plan, they could ask non-participants in the savings plan if they want to start saving, perhaps with some sort of Quick Enrollment. Or companies could provide a Quick Enrollment form or a computer terminal for employees to enroll in or make changes to their savings plan while they are standing in line to get a flu shot at the company’s annual flu shot clinic. Or companies could target employees who are about to pay off a loan with a message about increasing their savings rate after they have paid off the loan to get the loan payment that the employee is already used to making channeled into higher ongoing saving.”
Suggestion #6: Get Commitment. This isn’t just an old Jedi mind trick, it was actually a key technique employed by the Chinese in the Korean War to interrogate American POWs. But, used in the more tranquil setting of retirement savings, it can actually do some good. It might be as simple as getting employees to write down “I promise to save x%” to getting them to vow not to use their retirement savings to pay for their car. The issue of taking loans from 401k plans is controversial, with evidence showing those taking loans are less likely to meet their retirement goals. But, as Dr. Madrian says, “Loans are a double-edged sword. Knowing that you can tap into your account may make you more inclined to save in the first place, but the temptation to spend may then end up depleting your balances. My collaborators and I have some research suggesting many individuals don’t even want the option to tap into their savings balances. So one approach to fostering commitment would be to offer two types of accounts – one that has liquidity features like loans and one that does not so that individuals can choose to put at least some of their savings into a temptation free account. Employers can also place limits on loans. One extreme would be to eliminate them entirely, but a less draconian approach would be to limit the number of loans employees can take out, how often employees can take out a loan and the circumstances under which they can take out a loan.”
Suggestion #7: Mental Accounting. Some people have a single cookie jar for all their loose change. Other people have several cookie jars full of loose change, with each jar representing a different household expense. That’s an example of mental accounting. “Mental accounting is the process that individuals use to categorize savings or expenditures,” says Dr. Madrian. “In the context of savings, individuals may be saving for multiple reasons: an upcoming holiday or vacation, a child’s education or wedding, to purchase a car or a home, for retirement. Encouraging people to have multiple accounts for different reasons that they might save can increase total savings by reducing the possibility that people double-spend a saved dollar in an account used for multiple purposes. For example, if I have only one savings account and I contribute an extra dollar to that account, I can only spend that dollar on one thing. But if people have the money tagged in that account as going for many different purposes, their internal mental accounting system may not impose the constraint that a dollar I spend on my child’s education is a dollar I can’t spend on my next vacation. So, companies who have separate savings accounts for health care in retirement and other expenses in retirement may encourage more overall savings because having completely separate accounts doesn’t allow individuals to fool themselves into believing the same dollar can be spent twice on two different things.”
There you have it. Seven low to no cost ways to increase employee participation. As you can see from Dr. Madrian’s comments, many of these suggestions can be used in tandem. If you’re using any of these, please take the time to share your experiences in the comment section below.
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