NCPA - National Center for Policy Analysis

Raising Workers' Saving Participation Rates

March 13, 2003

How can we increase the retirement savings of low-income workers?

Economists looked at data from three employers that offered automatic enrollment in 401(k) plans. Employees could opt out, but they had to make an explicit choice to do so.

  • They found that the participation rate in these programs was spectacularly high, with over 85 percent of workers choosing the default option and enrolling in the 401(k) plans.
  • Unfortunately, almost all these workers also chose the default investment, typically a money market fund with very low returns and a low monthly contribution.

(Presumably the employers made the default investment highly conservative to eliminate downside risk and possible employee lawsuits.)

The net result was a modest increase in overall savings. In another study, economists examined a company where there was no default: within a month of starting work, employees were required to choose either to enroll in the 401(k) plan or to postpone enrollment.

  • By eliminating the standard defaults of nonenrollment or of enrollment at low rates, requiring an "active decision" by new employees raised participation rates from 35 percent to 70 percent.
  • Moreover, employees who enrolled in the 401(k) plan overwhelmingly chose high savings rates.

Thus designing plans with a default option with low returns may be a mistake, whereas forcing employees to make a choice seems to have a positive effect on overall savings.

Source: Hal Varian (University of California at Berkeley), "Why New Savings Plans Won't Work," New York Times, March 13, 2003; see also James Choi, David Laibson, Brigitte Madrian and Andrew Metrick, "For Better or for Worse: Default Effects and 401(k) Savings Behavior," Working Paper No. 8651, and "Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least Resistance," Working Paper No. 8655, both December 2001, National Bureau of Economic Research.

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