Thank Richard Thaler for that bigger nest egg

How the Nobel Prize-winner's theories have boosted participation in retirement plans

Oct 10, 2017 @ 4:34 pm

By Bloomberg News

If you have a 401(k) plan at work, there's a good chance that you're saving more for retirement because of Richard Thaler.

The Nobel Prize for economics tries to recognize important research with far-ranging consequences — but Thaler, awarded the prize Monday, may be its first winner to have had an almost immediate effect on millions of people's paychecks.

Over the last few decades, as more and more American employers killed off their pensions, workers were offered 401(k)s or similar retirement plans, with defined contributions instead of defined benefits.

These voluntary accounts should have worked, in theory. Standard economic theory assumes people act rationally: Workers, left to their own devices, should save and invest properly to meet their long-term goals.

But Thaler and other adherents of behavioral economics pointed out that workers saving for retirement can be their own worst enemies. Without help, Thaler argued, they'll never retire. "Probably [behavioral economics'] biggest impact is changing the way retirement plans are run," Thaler said in a speech at the CFA Institute's annual conference in May.

For years, Thaler championed the idea that employees should be "nudged" into joining retirement plans, a concept known as automatic enrollment. Rather than waiting for workers to fill out 401(k) paperwork, employers should automatically sign them up for the plans. If the employees aren't interested, they can always opt out.

In a survey by the Plan Sponsor Council of America (PSCA) last year, 58% of plans were automatically signing up workers. That's up from just 8.1% in 2000.

Thaler didn't come up with the idea of automatic enrollment, even if he helped popularize it in the 2008 bestseller he co-authored with Cass Sunstein, "Nudge: Improving Decisions About Health, Wealth, and Happiness." Thaler did, however, develop the notion of automatic escalation, also called "save more tomorrow," along with Shlomo Benartzi, a behavioral economist at the University of California at Los Angeles.

The goal of auto-escalation is to boost how much workers are saving. Setting aside 15% of your salary — an appropriate goal for many middle- and upper-income workers — can feel impossible. Auto-escalation addresses this by nudging workers to agree to future increases in their savings rates, usually by one percentagge point each year. A majority of employers now offer some kind of auto-escalation feature, according to the PSCA, though often workers need to proactively sign up for the option.

Automatic escalation can have a big impact on savings rates, according to a recent analysis by David Blanchett, head of retirement research at Morningstar Investment Management.

According to research by Jack VanDerhei of the Employee Benefit Research Institute, the combination of auto-enrollment and auto-escalation can substantially boost a worker's chances of retiring with enough income.

In Thaler's world of defaults and nudges, much depends on getting the details right. The wrong kind of nudges can be destructive. Many companies encourage workers to invest much of their retirement in company stock, something Thaler has argued is too risky for workers.

He also says many companies are encouraging workers to save too little. "One problem with automatic enrollment is most firms start people out at too low a rate," he said in his May speech.

Still, the best-designed nudge in the world won't get somebody to save enough for retirement if he or she simply isn't being paid enough. Thaler's nudges also can't reach the millions of Americans who don't have retirement plans at work — at least not yet.

That may change. Several states are setting up automatic individual retirement accounts (IRAs) aimed at the third of workers who don't have access to 401(k)s or pensions, and the details of many of those new plans seem ripped from the pages of Thaler's research.

Oregon, which launches the first auto-IRA program this month, will start workers out saving 5% of their salaries, unless they object. And their contributions will auto-escalate every year by one percentage point, rising until they hit 10%.

0
Comments

What do you think?

View comments

Upcoming event

Jul 09

Conference

Boston Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in six cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Most watched

INTV

Schwab's Jeff Kleintop: Prep for volatility given China trade uncertainties

China could be considered a developed market in five to seven years , according to Jeff Kleintop, chief global investment strategist, Charles Schwab.

INTV

Young advisers envision a radically different business in five years

Fintech and sustainable investing are two factors being watched closely by some of the 2019 class of InvestmentNews' 40 Under 40.

Latest news & opinion

TIAA exits the life insurance business

The move is a big deal for RIAs, experts say, since TIAA was one of only a few insurers to offer fee-only life policies.

Advisers step up efforts to help clients manage student loan debt

As some Democrats campaign to wipe the slate clean, financial planners focus on limiting the amount students borrow.

Funding for Reg BI, other SEC advice reform efforts denied in Waters amendment

House likely to approve measure that effectively kills rule package, but it faces uphill battle in Senate

Wall Street lashes out at Sanders' plan to pay off student debt with a securities trading tax

Financial pros argue that a transaction levy will hurt mom-and-pop investors along with investment houses.

GPB paid B-Ds and reps steep commissions to sell troubled private placements

GPB paid commissions of 9.3%, or $167 million altogether, on the firm's private placements.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print