Employers have increasingly been putting workers’ 401(k) plan savings on autopilot in recent years. However, new research suggests that the positive impact of automated retirement savings may not be as significant as originally thought. Factors such as workers cashing out their 401(k) balances when they leave a job can reduce the long-term effects of policies like automatic enrollment and automatic escalation. Co-authors of the study, who are pioneers in behavioral economics, highlight the importance of considering these factors in evaluating the effectiveness of automated savings strategies.
Automated savings have been a central part of 401(k) policies since the Pension Protection Act of 2006. Policies like auto-enrollment and auto-escalation aim to increase employees’ retirement savings by enrolling them in their company’s 401(k) plan automatically and gradually increasing their contribution rates over time. While these policies leverage people’s tendency towards inertia to boost savings, the study by Choi, Laibson, and Beshears found that the impact may not be as positive as previously believed. Despite the widespread adoption of auto-enrollment (used in about two-thirds of 401(k) plans as of 2022) and auto-escalation (used by 78%), the actual effect on savings rates may be lower than expected based on earlier research.
The recent research by Choi and his co-authors analyzed the impact of auto-enrollment on 401(k) contribution rates over workers’ careers. The study found that auto-enrollment led to an average increase of 0.6 percentage points in contribution rates, significantly lower than the 2.2-percentage-point boost suggested by earlier research. This discrepancy underscores the importance of considering factors like job turnover and early withdrawal of funds (leakage) from 401(k) plans in assessing the effectiveness of automated savings strategies. While auto-enrollment has been successful in getting more workers to save for retirement, leakage and other challenges can limit its overall impact on savings rates.
Leakage from 401(k) plans, such as cashing out funds before retirement, remains a significant issue affecting retirement savings. About 40% of workers cash out their 401(k) plans when they leave a job each year, totaling billions of dollars in lost retirement savings. Factors like workers forfeiting employer matching contributions and low acceptance rates of auto-escalation for savings rates further complicate the effectiveness of automated savings strategies. Job turnover can also disrupt auto-escalation, resetting contribution rates when workers change employers, making it challenging to maintain consistent savings levels.
Despite the challenges posed by leakage and other factors, auto-enrollment has generally been successful in increasing retirement savings participation among workers. However, there is still room for improvement in automated savings strategies to help workers save more effectively for retirement. Experts suggest higher default savings rates, coupled with employer matches, to encourage workers to save a higher percentage of their salaries. By addressing issues like leakage and increasing default savings rates, automated savings programs may have a more significant impact on workers’ retirement savings in the long run. Ultimately, ongoing research and efforts to enhance automated savings strategies can help improve retirement outcomes for workers in the future.
