Wealthier workers tend to benefit the most from automatic enrollment and contribution increases
Broadcast Retirement Network’s Jeffrey Snyder discusses auto features in today’s retirement programs with Taha Choukhmane, of the MIT Sloan School of Management.
Jeffrey H. Snyder, Broadcast Retirement Network
This morning on BRN, who benefits the most from retirement savings nudges? Joining me now to discuss this and a lot more, Taha Choukamani is with the MIT Sloan School of Management. Taha, so great to see you.
Thanks for joining us this morning.
Taha Choukhmane, MIT Sloan School of Management
Thank you. I’m delighted to be here.
Jeffrey H. Snyder, Broadcast Retirement Network
This is, and this is great. I’m excited because as I told you, selfishly, I grew up in the retirement industry. We’ve talked a lot about auto enrollment, auto escalation, all these auto features.
You and your colleagues did a lot of research into the impact and what that means to people spending behaviors. Tell us a little about the results and what you found.
Taha Choukhmane, MIT Sloan School of Management
Right. So we’ve had some early evidence from these nudges and auto enrollment that getting, you know, nudging people gets them to put more money in their retirement account. But whether that’s translating to actual additional savings is going to depend on how people finance those increases.
So if every time you put an extra dollar in your retirement account, you take on a dollar of credit card debt, or you reduce your outside saving by a dollar, you’re not going to end up with more money. You just move savings from one place to the other. And so in our research, which we did, which to merge data from pension, from UK workers, pensions account with their banking information, where we can see how much they spend on their credit card, debit card, outside savings to get at whether these increase in savings are real or whether it’s just moving money from one place to the other.
Jeffrey H. Snyder, Broadcast Retirement Network
And what did you what did you find? I guess it varies by income level. Right.
I mean, at the end of the day, if you have lower income, you’re probably going to do what you describe as move money and maybe spend more on your credit card as opposed to, you know, putting money into your retirement program.
Taha Choukhmane, MIT Sloan School of Management
Yeah. So what we found is that on average, when you get people to put an extra dollar in their retirement account, they’re going to cut spending by roughly 33 cents. Most of the drop in spending is going to come from things like restaurant and leisure.
So discretionary spending categories, you save more for retirement, you’re going to cut a little bit on your restaurant spending. But what was really fascinating was the heterogeneity. If you look at people who don’t have a lot of outside savings, you know, their checking account is close to zero.
They have no choice but to cut spending. So you push people who have very little liquid savings to save more, they cut spending. Now, on the other hand, if you look at people who have a lot of outside savings to start with, you nudge them, you push them to save more for retirement.
They do put more money in the retirement account, but their spending doesn’t change. They don’t change their spending habits, which means that the money has to come from somewhere else. And what we found is that the main place the money is going to come from is people running down their checking account balances.
We also see a small increase in credit card debt.
Jeffrey H. Snyder, Broadcast Retirement Network
And, you know, I think credit card debt now somewhere around 1.6 trillion. I mean, it’s so inflated, given everything that we’ve gone through in the last several years with the pandemic and some of the economic challenges we’ve had. What’s the lesson here, do you think, for policymakers, but also employers that are using these so-called nudge features, auto escalation, auto enrollment in their retirement plans?
Is there a lesson?
Taha Choukhmane, MIT Sloan School of Management
Yes, I think we have to be very careful about the design of these nudges. So in some other work I’ve done in the U.S., I find that in the short run, over a year, automatic enrollment increases contribution and average contribution participation by quite a lot. But then if you follow people over time, these effects and most of these gains are attenuated.
And over three to four years, there’s no distinguishable increase in average savings. OK, so that tells us that we have to be really careful about who we’re targeting with nudges or financial incentives. And what our results are telling us is that, you know, if we think that a lot of the incentives, the tax incentives, employer matching are taken up by precisely those people who have a lot of outside savings, then they’re not very effective.
This is just they’re just getting more money through the tax system and through employer matches without creating true new savings, simply moving money from one account to the other. So that can still be good if you think that it’s better to have money in retirement accounts rather than in checking account. It’s better invested, lower fees, but it doesn’t necessarily increase the amount of savings.
Whereas kind of thinking harder about how do we make these retirement accounts more attractive for people who don’t have a lot of liquid savings, who will actually cut spending, who have the most to benefit from these is, I think, an important question. And that raises the question of why aren’t these people saving more to start with? What is it about these accounts that’s less attractive for people who don’t have a lot of liquid savings to start with?
Jeffrey H. Snyder, Broadcast Retirement Network
And wouldn’t that just posit, I mean, they just don’t have enough money that maybe their income isn’t enough to put money away. And they need some of that money for their everyday expenses.
Taha Choukhmane, MIT Sloan School of Management
So there’s a question about do people have enough money? And in some of our work, we compare people who have the same wage. And so you can put money the same, but what you find is that single parents with kids are going to save less.
Those who have lower income parents, conditionally having the same income, are going to contribute less. So the way we interpret this is if you have a safety net, if you have a spouse that has a high income, if your parents have some income, then it’s OK to put money in a box and lock it for 40 years and earn all these great benefits. But if you don’t have that safety net, if you know that if your car breaks down, you’ll need the money, then that’s not very attractive.
And so thinking about the design of these accounts, what are the hardship exemptions from the tax penalty? Should it cover more situations like a family medical emergency? How should we design 401k loans?
Right now, you lose your job. You have to repay, in most cases, the balance of your 401k loan. Plus interest.
We should let people and plus tax penalties. And so all of these make these accounts not very attractive for people who don’t have a lot to start with and who are precisely people who would benefit the most. And there is some evidence from other authors, someone at the Wharton School that finds that when a plan introduces a loan option, participation increases.
So people are willing to save more if they have a sense that when they need the money, they can access it. But if you make it too restrictive, then it’s less attractive for people who don’t have a lot of savings to start with.
Jeffrey H. Snyder, Broadcast Retirement Network
So basically, I mean, we’ve done a good job in getting people into plans, but we’ve got to get to this next phase. It’s almost like the Auto Enrollment Auto Escalation that was part of Pension Protection Act in 2006. But we really need to kind of refine this.
And I think this is probably where policymakers in particular are really looking to do this. Taha, in the remaining time we have left, how do you follow up this research? So what’s next for you and the team in terms of maybe looking at nudges, but also looking at savings behavior?
Taha Choukhmane, MIT Sloan School of Management
Yes, I think in terms of the research we’re doing now, I think I share your view that the pension protection had some great successes. I think automatic enrollment has reduced inequality in these accounts. You know, you’re lifting a lot at the bottom of the income distribution to save more in terms of asset allocation, getting people into better diversified asset allocation.
But it doesn’t solve the problem. And in particular, there hasn’t been a lot of thinking on the order side. There’s the nudge, but there’s also the carrot, the financial incentive.
And a lot of our work right now is trying to think about these financial incentives. We estimate that 40 percent of the money in retirement accounts in 401ks represent tax subsidies and employer subsidies. So all these financial incentives, it’s a lot of money.
It’s almost $400 billion a year, one and a half percentage point of GDP every year. And so how can we change the design so that more of the money goes to the people who would benefit more, more of the money goes to people who would actually save more rather than just move money from one account to the other? And so that’s kind of some of the work we’re engaged in.
How do we design better financial incentives?
Jeffrey H. Snyder, Broadcast Retirement Network
Well, your timing couldn’t be more, couldn’t be better, because I know with this new Congress and new president, taxes and tax incentives are going to be top of mind. I think they’re going to be debating that in perpetuity. Taha, we’re going to have to leave it there.
Great research, great work. Thanks for joining us. And we look forward to having you back on the program again very soon.
Taha Choukhmane, MIT Sloan School of Management
Thank you. Appreciate it.
Jeffrey H. Snyder, Broadcast Retirement Network
This was really fun. And don’t forget to subscribe to our daily newsletter, The Morning Pulse, for all the news in one place. Details at our website.
Until tomorrow, I’m Jeff Snyder. Stay safe, keep on saving, and don’t forget, roll with the changes.
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