Are Employers Hindering Retirement Savings Progress?

A research paper published by the Social Science Research Network (SSRN) claims employers design their defined contribution (DC) retirement plans to attract labor, and often exploit problematic employee retirement savings behaviors.

“The design of the ‘choice architecture’ of these plans is delegated to employers… If those workers make systematic mistakes in their retirement savings decisions, then the labor market will produce incentives for plan designs that generally fail to effectively address the problems. Indeed, the presence of workers who undersave due to myopia results in equilibrium employer plan designs that exploit the myopic by lowering their total compensation,” say researchers Ryan Bubb and Patrick Corrigan, from the New York University School of Law; and Patrick L. Warren from Clemson University – John E. Walker Department of Economics.

For example, most employers choose an automatic enrollment default deferral rate of 3%. The authors concede that the use of automatic enrollment can result in at least some retirement savings by employees who would otherwise have initially contributed nothing to the plan. However, they note that these defaults are also sticky in the opposite direction, and claim that evidence shows many workers who would have enrolled at higher savings rates voluntarily, will instead stick with a lower default savings rate in an opt-out design.

Another example concerns matching contributions. At the time naïve employees are choosing among competing compensation contracts in the labor market, they will overvalue employers’ offers to match retirement plan contributions since they will overestimate how much they will in fact save for retirement, the researchers contend. Employers actually save money on wages as these workers put more weight on present consumption, and will choose to save less and get less of a match.

For example, the paper says, “Suppose an employer offers a salary of $100 and also offers to match the worker’s first $5 in retirement savings dollar for dollar. Suppose a naïve, myopic worker believes he will save $5 under this contract and therefore thinks it will generate $105 in total compensation. But once he takes the contract, that naïve myopic worker will save only $2, say, and hence actually receive only $102 in compensation.”

The researchers contend their analysis calls into question the longstanding delegation of retirement savings choice architecture to employers. “The current heavy reliance on employers to design and provide retirement savings vehicles results in perverse outcomes, especially for the very undersaving workers that are the main subjects of regulatory concern,” they write.

They suggested supplanting the current system of employer-provided pension plans with a new federal defined contribution plan, designed by a federal agency and not linked to any particular job, could improve savings outcomes at little to no fiscal cost to the government.

The paper, “A Behavioral Contract Theory Perspective on Retirement Savings,” may be downloaded from here.