CHICAGO (Reuters) - How to get people to save for retirement? There are two schools of thought: cajole and educate, or give people a little push in the right direction.
Pushing has been ascendant over the past decade for a simple reason: it works. Fueled by “behavioral economics” - which focuses on the psychological and emotional factors in people’s economic decision-making - this approach holds people will save if the process is easy and if they are given a gentle nudge.
Workplace retirement plans have successfully boosted participation and saving rates with features like default auto-enrollment for new workers and auto-escalation of contribution rates. They have also added popular target date funds, which automatically maintain an age-appropriate investment balance between equities and fixed income.
State governments have drawn on these behavioral economics lessons as they target a different problem: roughly half the U.S. workforce lacks access to any kind of workplace retirement plan. The largest coverage gaps can be found at small employers, who do not want to deal with the cost or regulatory burden of administering 401(k) plans.
Seven states have passed legislation authorizing the launch of government-sponsored, low-cost savings programs for these workers, and many will include the automated features that have worked well in private sector plans. Most of the state programs require employers without their own plans to set up payroll deductions for automatic contributions to a publicly run IRA account. And most of the plans will use “gentle push” structures, auto-enrolling workers, but giving the option to opt out if they choose.
So this idea makes clear sense. Yet the state auto-IRA plans hit a roadblock last week when the U.S. Senate voted to eliminate regulatory support for them.
The regulatory support in question is a ruling issued last year by the Department of Labor (DoL) that exempts state plans from the Employee Retirement Income Security Act of 1974 (ERISA) if they meet certain conditions. That provides important reassurance to employers participating in the plan, who worry about compliance cost and legal liability under ERISA.
The Senate - following up on earlier action in the House - approved legislation pulling back the DoL regulatory guidance, and President Donald Trump is widely expected to sign off on the measure. California and other states are vowing to press on with their auto-IRA programs, which means the issue of ERISA liability will be decided in the courts - a process that likely will drag on for years. The uncertainty also could slow the momentum in other states considering similar programs.
Congress erected the roadblock to appease powerful elements of the financial services lobby. I am convinced their motive is to protect profit: they simply do not want to compete with low-cost government-sponsored “public option” programs, which will cut into the high-fee retirement products they sell to small businesses.
For public consumption, their explanations are different. Opponents argue that consumers need the protections of ERISA - an argument that does not make sense since most IRAs are not covered by ERISA. And they will tell you that what we really need is better “cajole and educate” efforts to persuade people to save more. If workers would only take the time to become more financially literate, we would see higher saving rates.
But financial literacy education programs have failed to make much of a dent in the problem. “Negligible” is the word used to describe their impact by one recent academic review (bit.ly/2q0ZpCJ).
Complexity and consumer inertia are more significant hurdles to saving. Consider IRA accounts, which require proactive steps to open along with a fair amount of paperwork. IRAs hold nearly half of all assets in private sector retirement accounts, according to a study released last month by the Center for Retirement Research (CRR). But nearly all of the assets represent rollover dollars from 401(k) plans; individual contributions in 2014 accounted for just 13 percent of new inflows.
“Behavioral economics teaches us that inertia works against complicated products like this, so a very small number of people open them,” said Jeremy Smith, director of the Retirement Savings Initiative at the Aspen Institute’s Financial Security Program. “You’ll sometimes hear arguments that people don’t save because they just aren’t interested, but that is belied by the track record with auto-enrollment workplace plans,” he adds. “It turns out that if you make it easy, lots and lots of people will participate.”
Indeed, Vanguard reports that employees in plans with auto-enroll features have a participation rate of 88 percent, compared with only 58 percent in plans with voluntary enrollment. For lower income workers (less than $30,000), participation rates are more than double.
Mandatory, universal saving programs in other countries also are showing impressive results. Australia has had a mandatory program since 1992; Britain and New Zealand both have had programs for less than a decade. All three programs have boosted the percentage of pre-retirement income available to workers once they retire, according to the Organization for Economic Cooperation and Development; the gains are especially strong for low-income workers.
The state auto-IRA plans have the potential to help 55 million people gain retirement plan coverage at work, AARP estimates. No amount of cajoling will get us even close.
(The opinions expressed here are those of the author, a columnist for Reuters.)
Editing by Matthew Lewis