Increasing Retirement Account Participation

If the goal is to get more employees to open 401(k) plans, then employees should not be required to actively initiate participation. Rather, they should be enrolled automatically (while retaining the option to drop out).

Employers can greatly increase both participation and investment in 401(k) retirement accounts by automatically enrolling employees in the plans, boosting the default contribution rate and the employer match, and allowing all departing employees to retain their savings in a retirement fund rather than forcing some to liquidate their assets. These are among the findings of a study by James Choi, David Laibson, and Brigitte Madrian -- Plan Design and 401(k) Savings Outcomes (NBER Working Paper No. 10486) -- which focuses on improving the effectiveness of the widely-used accounts that have replaced guaranteed pensions as America's primary, privately-sponsored source of retirement income. "The central finding -- that plan design matters in economically significant ways -- places a tremendous burden on both employers and government regulators," they write. "Whatever plan design an employer chooses will favor certain outcomes over others."

For example, if the goal is to get more employees to open 401(k) plans, then employees should not be required to actively initiate participation. Rather, they should be enrolled automatically (while retaining the option to drop out) or at least be required to "actively indicate" by a specific date whether or not they want a 401(k). Companies with automatic or "active decision" enrollment procedures have a far higher percentage of their employees investing in 401(k) plans than do companies in which it's up to the employee make the first move, the authors observe. "If the goal of either employers or government regulators is to achieve the highest possible 401(k) participation rate, the single most effective intervention is automatic enrollment," they write. There is evidence that "facilitating enrollment" by requiring employees to make a decision one way or another by a date-certain may provide similar gains. In addition, the authors uncover other ways employers can boost participation, include initiating or increasing the company contribution to the plan, allowing employees to take out loans against their 401(k), and making sure that the menu of investment options is not so complicated as to discourage enrollment.

Choi, Laibson and Madrian also consider approaches that might prompt employees to put a higher percentage of their salaries into a 401(k). For example, one of the drawbacks of automatic enrollment is that under such systems employees are less likely to boost contributions beyond the default amount set by the employer. One way to address this problem, the authors contend, is to offer plans with a feature that, over a set period of time, automatically escalates the income percentage employees contribute. They cite a recent experiment in which, after three years, employees who had selected the automatic increase feature were contributing 11.6 percent of their pay to their 401(k) while those not using the feature were contributing 8.7 percent. They also observe that, just as it influences participation in 401(k) plans, initiating or boosting an employer match can result in higher employee contributions as well.

In addition, Choi, Laibson and Madrian encourage employers to think about how investment strategies can be influenced by the design of a particular 401(k). For example, they note that while it's important to provide employees with a menu of investment choices, there is evidence that the mix of offerings in certain plans prompts employees to skew their portfolio toward "more conservative assets, such as money market funds" over investments in assets, such as stocks, which might be more likely to fatten retirement savings.

Choi, Laibson and Madrian also caution that some plan designs may steer employees toward putting an "excessive" amount of their 401(k) savings into company stock. Some aspects of a plan's design -- such as providing the employer contribution in company stock -- can lead to situations in which more than half of an employee's retirement savings depend on the performance of company shares. (The authors note that under federal law "defined benefit" employee pension plans can contain no more than 10 percent of company stock, but 401(k) plans are exempt from this rule.)

Finally, Choi, Laibson, and Madrian observe that people are more likely to keep saving for retirement if they're not forced to convert their 401(k) into cash when they leave a particular job. For some time now, if departing employees have had less than $5,000 in a 401(k), federal law allowed employers to force them to accept a cash payment. While employees can simply take this money and put in into a new retirement account, studies show that in most situations they tend to spend the cash rather than re-invest it. The authors note that a new law set to go into effect this year requires employers to set up an individual retirement accounts (or IRAs) for departing employees with relatively small account balances (those between $1000 and $5000) rather than compelling them to liquidate their 401(k).

Drawing on their own research and that of others, the authors conclude that while it may be tempting for employers to adopt a "laissez-faire" or hands-off approach to 401(k) plans -- leaving it up to employees the enroll in the plans and managing their contributions and investment choices -- the fact remains that even with this approach employers are still making choices that will influence the quantity and quality of employee retirement savings. "In short, there is no escape," they conclude. "Policymakers should also recognize the importance of plan design, as they can legislatively encourage and facilitate employer adoption of particular 401(k) designs that foster better retirement savings outcomes for employees."

-- Matthew Davis