Auto-enrollment and auto-escalation 401(k)s were supposed to help people save for retirement. Here’s what happened instead.

By Jessica Hall

Behavioral finance nudges and other useful features have hit a surprising snag

We may be our own worst enemy when it comes to retirement savings.

Innovations such as auto-enrollment, where an employer automatically places a worker in the company’s retirement plan, and savings auto-escalation, which automatically increases a worker’s retirement plan contribution, were intended to increase overall retirement savings. But new research has found that these features help less than previously thought, mainly because people end up sabotaging their own retirement success.

“We’re not saying auto features are bad or useless. We think these policies are a good idea, but they’re just not as effective as originally thought,” said Yale School of Management finance professor James Choi.

“In the real world, looking at how people behave — people quit their jobs, cash in their 401(k)s, or drop their savings rates — it’s different once human behavior plays a role,” Choi said.

In the new research, “Smaller than we thought? The Effect of Automatic Savings Policies,” Choi and colleagues studied nine 401(k) plans and found that automatic enrollment and default automatic escalation are actually less effective at increasing retirement savings than before. suggested research.

This is because people leave their jobs before their matching 401(k) dollars are fully vested; start over at new companies at the entry point for 401(k) savings rates rather than their previous, higher savings rate; or they quit a job and liquidate their 401(k) funds instead of rolling them into a new retirement savings plan, Choi said.

Read: What are attribution programs? They can turn “free” 401(k) matching money into “fake” money if you don’t know.

“The job transition point is a very critical transition. People lose bad dollars and don’t think about it or factor it into their decision. Or they use their savings for immediate needs rather than saving for retirement, which seems like forever away. Choi said. “It’s not about moving jobs, say, that’s a bad idea. It is the decision to collect”.

In fact, 42 percent of 401(k) balances are cashed out upon leaving a job, the research found.

“The rules allow this. The US retirement system is permissive about taking pension money before retirement. Secure 2.0 has made it even easier to take money out,” Choi said.

The retirement legislation known as SECURE Act 2.0 requires most 401(k) retirement savings plans established after 2022 to automatically enroll new employees and automatically increase their contribution rate. However, features of the law now allow you to use retirement funds more easily, such as being able to withdraw $1,000 a year for emergencies.

Read: Taking $1,000 from your 401(k) for emergencies is easier than ever — but consider these options first

Also, people with limited retirement savings often do the worst when it comes to changing jobs. For example, if an employee has a retirement balance of less than $1,000, an employer will mail you a check for your savings balance. Most people, instead of putting it in an IRA, cash the check and spend it, Choi said.

For people with balances between $1,000 and $7,000, the employer can roll those funds into an IRA of their choice — but the funds are cash rather than an investment, Choi said. The employee has to make an investment selection for that money, and often they don’t, so the money is just in cash, he said.

With automatic escalation, research has found that nudges to increase people’s savings rate don’t work because people drop out of the program. For example, the rate of acceptance of the auto-escalation standard was 43% on the first time of escalation, 36% on the second time and 29% on the third time, the research found.

Incorporating human behavior and its effect on pension funds, the researchers found that, overall, auto-enrolment increases net retirement contributions by just 0.6% of income per year and self-escalation by just 0.3% of income per year .

So what can be done to make retirement savings more efficient?

“Making pension savings accumulated in previous jobs less easily accessible, creating an infrastructure that allows high contribution rates achieved in a previous job to be automatically applied to the next job and/or making the contribution level of auto-escalation to depend on something like employee age. of current workplace tenure alone can significantly increase the impact of automatic policies on retirement savings accumulation,” the researchers said in the paper.

Choi also added that workers should work hard to maximize any matching dollars they receive from an employer and leave no money behind.

“When you change jobs, part of the calculation should be how much you will lose. People don’t seem to pay attention to the vesting schedule when they change jobs,” Choi said. “And people should be more reluctant to cash out when you leave a job.”

-Jessica Hall

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09-21-24 1151 ET

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