As the economic recession spreads, many Americans are struggling to make it to the next paycheck—if there is a paycheck. Understandably, they don’t want to think about more bad financial news on the horizon: the fact that most people aren’t saving nearly enough money for retirement. But according to Brigitte Madrian, the Aetna Professor of Public Policy and Corporate Management, that more-distant crisis isn’t inevitable. With commonsensical tweaks of the current system, government and employers can dramatically help people save the money now that they will need later.

Since 2001, Madrian has focused on what may sound like an esoteric corner of the dismal science: the outcomes of default options in employer-sponsored defined-contribution savings plans. But translated into plainer language, her findings are anything but abstract: The fallback choices that a company offers employees in retirement-savings plans can make it very easy or very hard to save for old age.

Luckily, government leaders have caught on to her arguments. Five years after Madrian first published on the topic, the U.S. Congress passed the Pension Protection Act of 2006, which incorporated many of her recommendations. Unlike her earlier scholarship on health insurance—“People were interested, but nothing ever changed,” she says with a laugh—her retirement studies have sparked swift reform. “It’s rewarding to do research that’s having real-world impacts almost in real time.”

About two-thirds of workers are in companies with employer-sponsored defined-contribution savings plans. Typically, these plans give workers 50 cents on the dollar, for up to 6 percent of their salary. In other words, if you save at least 6 percent of your pay, your employer matches that with an additional 3 percent of compensation. The arrangements “are an effective way to help individuals save more,” Madrian says. “They work because there’s a financial incentive for employees to save. And they work because of payroll deductions: The money that you don’t see is the money you don’t miss.”

Yet puzzlingly, of the employees eligible to benefit from this largesse, only about half take full advantage of the match—either because they don’t participate at all, or because they are saving at a rate below the cap for an employer match. That means people are leaving money on the table. “Think about what kinds of raises employers dole out,” Madrian says. “In a typical year, a worker might get a raise of 3 percent. If the employer is matching 50 cents on the dollar up to 6 percent of pay, and if you put 6 percent into the plan, it’s like getting a 3 percent raise. Nobody walks into their employer’s office and says, ‘I don’t want my raise next year.’ But if you’re not saving in a plan where there’s a match, that’s essentially what you’re doing.”

Why don’t people take advantage of this free money? One reason appears to be human nature. “Saving is a task that is particularly susceptible to procrastination,” Madrian says. “The benefit from doing it today is that you consume less—which most people view as a cost—but you have a more secure retirement 10, 20, 30, or 40 years down the road. It’s not a particularly salient issue for most people—there aren’t ads on TV telling you to save for retirement, and people who are young are not watching their friends retire. Retirement saving is also a complicated task—and individuals have a tendency to put off things that they view as being complicated. And there are no deadlines for getting it done.”

But another reason many people don’t save is that companies make it unnecessarily cumbersome to do so. As Madrian’s research makes clear, some of the most effective policies to boost retirement savings actually leverage human inertia—but to financially savvy ends.

For example, companies that offer automatic enrollment, or “opt-out,” plans—where employees are automatically signed up for the plan unless they choose to opt out—see far higher participation rates than do firms that require employees to sign up, or “opt in.” Indeed, the differences are stark. At one company Madrian studied, participation rates for new employees shot up by 35 percent when opt-out was launched. In companies with automatic enrollment, participation rates generally exceed 80 percent. “I’ve seen companies with participation rates as high as 95 percent—virtually everybody,” Madrian says. Further easing the enrollment process, opt-out plans offer an automatic default contribution rate (percent of pay) and a default asset allocation (what fraction of the savings goes to stocks, bonds, etc.). The employee can always choose a different arrangement—but employees who do nothing will still be saving.

Another option that energizes retirement saving is “quick enrollment plans,” which simplify signing up if firms don’t offer automatic enrollment. Before quick enrollment plans, workers had to choose an asset allocation when they signed up. “Many individuals are not financially sophisticated and don’t know how to think about the optimal asset allocation for themselves,” says Madrian. “And because they don’t know what to do, they don’t do anything. It’s a stumbling block for signing up.” Quick enrollment plans remove that hurdle by giving employees a default asset allocation—from which they can of course opt out, if they choose.

Another beneficial option, studied by Richard Thaler of the University of Chicago and Sholomo Benartzi of UCLA, allows workers to escalate their contributions. In this scheme, contributions begin at, say, 3 percent of pay, but then increase yearly by 1 percent, up to 6 percent or so annually. According to Madrian, “Contribution escalation is a way to simultaneously get employees to start saving at a rate at which they are comfortable today, and put into motion something that will get them saving more in the future. They can financially secure retirement without being required to do anything in the future.”

Notice what all these plans have in common: They turn procrastination into an asset. In a 2006 article for The Milken Institute Review, Madrian and her co-authors proposed what seems like a disarmingly commonsensical idea: “The path of least resistance should generate the greatest good.” But among her then-colleagues at the University of Chicago, where the rational model of Homo economicus reigns supreme, the statement amounted to heresy. “They were quite skeptical about this,” she says. “Their view was that individuals know what’s best for them, and if people really wanted to be saving for retirement, they would have signed up for a savings plan on their own. So if you’re automatically enrolling them, you’re basically duping people into saving when they don’t want to do that.”

Yet in study after study, Madrian has found that employees simply don’t hew to that rational ideal. “There are some situations where the standard models don’t work,” she says. “I’m working in one of those areas. Most individuals who become participants because of automatic enrollment actually do want to be saving—the problem is that they don’t know how to do it, and as a result they do nothing.”

Madrian’s investigations therefore take up where the rational economic actor strays off course. “If you have a strong financial incentive to save, why isn’t everyone doing it?” she asks. “And why do you get such dramatically different outcomes when you have automatic enrollment versus when you don’t have automatic enrollment?” she asked. “Financial incentives get you 60 percent of the way there—but they don’t explain everything. Much of what this research agenda is about is trying to get at the issue of ‘What else matters?’ And when is the ‘what else’ more important than financial incentives? I want to understand what drives human behavior.”

But there’s also a larger issue at play: making social institutions work for the common good. “To me, it seems fairly intuitive—not just in automatic enrollment plans, but in how the whole world is structured—to set up institutions so that what happens is what people want to have happen, and what doesn’t happen is what people don’t want to have happen. The fact is, most employees want to be saving. Instead of requiring them to sign up to do what they want to be doing anyway, why don’t we just make it automatic, and let the people who don’t want to be doing it—who are a minority of the employees—opt out?”

That idea was part of the impetus behind the Pension Protection Act, which gave incentives for companies to offer opt-out plans and other policies that would help workers save. So obvious were its benefits, that the legislation received strong bipartisan support. Republicans liked the idea that it wasn’t a mandate and that it was supported by the financial services industry. Democrats liked how the law leveled the playing field, raising participation rates among economically disadvantaged groups that had historically saved less. In economics, this happy outcome is known (after an Italian economist) as a “Pareto-efficient policy”: Lots of people win and nobody loses.

Even with the new law in place, however, not everyone is winning. Madrian cites two gaping “holes” that the U.S. government still needs to fill. One is the sizable fraction of workers who are in companies—mostly of small to moderate size—that don’t have employer sponsored savings plans. “We need to expand the benefits of these plans to a larger segment of the population,” she says.

The second challenge is helping retirees hold on to what they have. “Say we’ve turned people into successful savers,” Madrian says. “Then what do we do? We need to turn them into successful consumers of what they have saved in retirement.” In the current downturn, people who have been retired for five or ten years, and who thought they had saved enough, have seen their nest eggs cut in half. “We need to structure incentives so that this does not happen.”

With no end in sight to the global recession, Madrian has straightforward advice for those who want to ensure retirement security. First, if you have an employer match, save at least to the point where you receive the full match—and more, if you can. Second, diversify your holdings—but not in company stock. “Employer stock is not a good investment in a retirement-savings plan. If the employer stock does poorly, the likelihood that you’re going to be laid off and lose your job is probably going up at the same time.”

If you don’t have access to a job-sponsored savings plan, set up an IRA and, if possible, arrange for automatic monthly transfers so that you don’t have to continually take action (or lapse into inaction). Don’t wait until you can save what you think you ought to be saving—do what you can now and revisit your decision later, when you may be able to set aside more.

“When saving for retirement, you really only get one chance to do it right,” Madrian says. “You don’t get to learn from your mistakes, you don’t get a do-over.” At the end of the day, “very few people complain that they saved too much.” 

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