Exclusive Interview with Alicia Munnell: Auto-Enrollment Without Auto-Escalation Reduces Deferral Rates
We’ve had the opportunity to interview nationally recognized retirement researcher Alicia Munnell on several occasion during the course of our normal reporting. It was an honor for us, then, when she graciously agreed to participate in our monthly Exclusive Interview series. Alicia H. Munnell is the Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management. She also serves as the Director of the Center for Retirement Research at Boston College. Before joining Boston College in 1997, Professor Munnell was a Member of the President’s Council of Economic Advisers (1995-1997) and Assistant Secretary of the Treasury for Economic Policy (1993-1995). Previously, she spent 20 years at the Federal Reserve Bank of Boston (1973-1993), where she became Senior Vice President and Director of Research in 1984.
FN: Our readers are always interested in the back story of our interview subjects. How did you end up where you are today? What triggering experiences had the most impact in your career choice? If you had the choice, is there anything you would do different?
Munnell: I majored in economics by default; worked for men who had daughters; and really liked the idea of tackling issues involving big bucks, which led me to study retirement income programs like Social Security and employer pensions.
FN: Last fall you co-published a report (“How Has Shift To Defined Contribution Plans Affected Saving?” Center for Retirement Research at Boston College, September 2015, Number 15-16), that dramatically changed your perception regarding the success of the 401k plan. Tell us a little about the “before” and “after” of this story. What were your perceptions about defined contribution plans prior to conducting the research on this paper? What were the specific research points that prompted you to reconsider those earlier thoughts? How can others – primarily practitioners – use this data to help people save for retirement?
Munnell: Our thought going into the study was that the shift from defined benefit to defined contribution plans had reduced the amount of total saving that was occurring in the employer-sponsored retirement system. But we never had seen any data to support or refute this hypothesis. Recent changes to the government’s National Income and Product Account database provided an opportunity to shed some light on the issue. Our main finding was that the shift to defined contribution plans appears to have not resulted in less total saving. But it is quite possible that the shift to defined contribution plans has led to distributional differences in the accumulation of retirement assets – for example, lower income workers could be saving less than higher income workers than under the traditional defined benefit system. This question is one that we are currently examining. One last thing – one clear-cut effect of the switch to a defined contribution system is that individuals, rather than employers, now bear all of the risk of providing for their retirement.
FN: In October of last year I spoke to Teresa Ghilarducci following her keynote at a forum of business writers and editors. The positions she advocated there seemed to be in contradiction with the conclusions from your report. I asked her if she was aware of your (then very recent) publication and she said she wasn’t. Have you had a chance to speak to her about your report? How would you contrast her position with the findings of your report?
Munnell: Teresa and I are in contact on various topics. In fact, we had a lovely lunch together recently in Rome, but we have not had a specific conversation about that study. Note that the study doesn’t change anything about the retirement challenge that today’s workers are facing, an issue that both Teresa and I care deeply about. Individuals will need more retirement income due to improving longevity, growing health care costs, and low interest rates. And our major sources of retirement income will not provide enough. Social Security replacement rates are actually shrinking and 401k balances are far too small to allow many to maintain their pre-retirement standard of living when they retire. In addition, at any given point in time, about half of private sector workers are not participating in any employer-sponsored retirement savings plan.
FN: You recently appeared before the Senate committee hearing on retirement plans and made some very specific suggestions. Can you enumerate those again for our readers?
Munnell: Yes. First, I indicated my general support for the efforts of the Committee’s bipartisan working group that has proposals to help reduce the pension coverage gap and encourage saving among lower income workers. However, much bolder changes are needed to address the retirement saving shortfall, so I offered two specific changes of my own: 1) require 401k plans to adopt auto-enrollment and auto-escalation, retaining the ability for workers to opt-out of these arrangements; and 2) enact auto-IRA legislation at the national level to provide coverage to those workers who currently lack it.
FN: While the idea of a “default” auto-enrollment provision in all plans is sound, not all employees have the same financial needs as others. This being the case, would you advocate the standard “opt-out” choice remains or do you see a need to make opting out only available on a “hardship” basis?
Munnell: Yes, as noted in my previous answer, my proposal would definitely allow individuals to opt out. The idea of auto-enrollment is to nudge individuals toward participating without requiring them to do so.
FN: You’re proposed auto-enrollment number is 6%, much high than the average default rate (and still considerably lower than the target deferral advocated by many financial advisers). What is the percentage deferral that you think employees should target? How does default auto-escalation policy help employees get there and what percentage increase should that be set at?
Munnell: Yes, 6 percent is just my suggested starting point. I believe that it is absolutely necessary to have auto-escalation in the default contribution rate until the combined employee contribution and employer match reaches 12 percent of a worker’s salary. Auto-enrollment without auto-escalation would actually reduce contribution rates, as research has shown.
FN: What are the three best improvements you’ve seen in the defined contribution marketplace in the last 10-15 years?
Munnell: 1) The adoption of auto-401k plans by some firms; but this positive development has not spread far enough and seems to have stalled out in recent years; 2) The Labor Department’s focus on investment fees, along with some moves within the industry to find lower-cost ways to invest retirement assets, have helped to bring fees down, although average fees are still too high; and, 3) The declining share of assets invested in company stock.
FN: What are the two most important improvements you feel need to be implemented in the defined contribution marketplace in the next 10-15 years?
Munnell: 1) Auto-enrollment and auto-escalation in all 401k plans, covering both existing workers and new hires; and, 2) A reduction in leakages, which requires some tightening up by the federal government such as not allowing cash-outs when people change jobs and raising the age for penalty-free withdrawals above 59½
FN: Turning the conversation to defined benefit plans, what do you see as the best way to address the looming Social Security Crises? How do you think a “Child IRA” might best be utilized as a way to fundamentally change the role of government in retirement planning? [Editor’s Note: If you’re not familiar with the Child IRA, you can read about it here: http://www.benefitspro.com/2014/02/26/this-idea-will-solve-the-retirement-crisis-guarant and here: http://www.benefitspro.com/2014/04/02/its-time-we-create-a-child-ira.]
Munnell: The best way to address the Social Security challenge is to increase the revenue going into the system, which means some combination of higher payroll tax rates, an increase in the payroll tax cap, and perhaps more unorthodox ideas like transferring the program’s legacy cost burden to the income tax or investing a portion of Social Security’s reserves in equities. The reason for focusing on the revenue side is that benefits are already modest and replacement rates are declining under current law, so further reductions would only make the retirement security challenge worse.
With respect to the “Child IRA,” the idea of starting to save very early for retirement is a fine notion. Realistically, though, very few Americans save for such purposes on their own. My sense is that only a fraction of people would take much advantage of a Child IRA. Now if you were to couple the Child IRA with some sort of government match and auto-enrollment, that could change things.
FN: Can you give us a sneak preview of your latest research?
Munnell: As I mentioned earlier, we are currently looking at the distribution of defined benefit (DB) and defined contribution (DC) wealth by income level to see if DC wealth is more skewed to higher income individuals than DB wealth.
FN: Where can readers go to learn more about your research?
Munnell: Everything is on the website of the Center for Retirement Research at Boston College (http://crr.bc.edu).
FN: Is there anything else you would like to add?
Munnell: Our nation is really facing a retirement income crisis, so it is necessary to act soon to avert it.
FN: Professor Munnell, thank you very much for taking the time to share your thoughts and ideas with our readers. We continue to be impressed with your depth of research and encourage our readers to continue to watch for more news on that front by going to your web-site.