Should Employees Automatically Be Signed Up For a 401(k)?

05.29.07 | Money | 0 Comments | by junger

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One of the first steps to getting on track financially is start taking advantage of opportunities available to you. For many workers, the biggest missed opportunity is a 401(k) and the company match of basically free money.

But what if workers couldn't miss out on a 401(k) — because they were automatically signed up for it?

The Wall Street Journal's Econoblog took a look at this possibility, bringing Richard Thaler, a professor of economics and behavioral science at the University of Chicago's Graduate School of Business, and Mario Rizzo, a professor of economics at New York University and director of NYU's Program on the Foundations of the Market Economy, to discuss behavioral economics and whether or not employees should automatically be enrolled in a 401(k) plan.

Thaler argues in favor of "libertarian paternalism" — what he calls "nudges" toward the right direction for people.

Consider two examples, both designed to increase savings. The first is to enroll people, automatically, into savings plans — while allowing them to opt out. The second is the Save More Tomorrow plan, which allows employees to commit themselves now to increasing their savings rates later, when they get raises. Both approaches have been remarkably successful.

Well-chosen default rules are examples of helpful "choice architecture." Since it is often impossible for private and public institutions to avoid picking some option as the default, why not pick one that is helpful?

Rizzo doesn't necessarily argue against automatic 401(k) enrollment, but he disagrees that it is the "libertarian" thing to do.

Thaler says that those automatically enrolled in 401(k)s haven't quit, so they must be benefiting. This is an odd claim for a behavioral economist. Why would failure to change indicate a benefit? When the default is non-enrollment, Thaler says that individuals tend to stay in it because they're irrationally biased toward keeping the status quo.

The mistakes of bureaucrats, politicians and voters aren't as likely to be corrected by individual or social processes as errors made in the private sphere. Why? Because bureaucrats and politicians don't care about private welfare as much as individuals do and voters don't have much incentive to become informed. So people — who make imperfect decisions — tend to do less harm if they "nudge" only themselves and not others through policy choices.

In a study from the National Bureau of Economic Research, "Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least Resistance," automatic enrollment is claimed as one way to increase 401(k) savings.

The typical 401(k) plan requires an active election on the part of employees to initiate participation. A few plans have implemented automatic enrollment. Note that automatic enrollment does not require the participation of employees — it just makes participation the default decision. As illustrated in figure 1, automatic enrollment dramatically increases the percentage of workers who participate in the plans. Fewer employees enroll if they need to "do something" to participate, as compared with programs where they have to "do something" not to participate. The path of least resistance matters a lot.


It is clear from these findings that companies can do quite a lot more to promote retirement saving than just implement a 401(k) plan, and counting on employees to take it from there. Plan design decisions like automatic enrollment, higher default contribution rates, default investment allocations with higher expected long-run returns, and pre-commitment mechanisms to in-crease future contributions can have a huge influence.

So should companies automatically enroll their employees in a 401(k) plan?

My short answer: if they want.

There's no reason companies should be forced to automatically enroll their employees, but if they feel that it's important for their workers, then why not? The "libertarian" argument seems silly here, unless the government (stupidly) gets involved. A company's decision is a company's decision.

I'm not going to argue that companies should automatically enroll, but I wouldn't argue against it. It should be left up to the individual company.

(Links via Freakonomics)

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