There are two types of retirement savers when it comes to an employer-sponsored retirement account: those who are active and others who are passive.
Knowing which you are may help you save more for the future.
Passive savers are more likely to rely on auto-enrollment, where their companies take the initiative to place them in a retirement account upon employment, according to new research recently distributed by the National Bureau of Economic Research and written by researchers, at Stanford, University of Minnesota, London School of Economics and Political Science and Claremont Graduate University. Active savers would more likely opt-in to their own employer-sponsored plan.
Financial literacy and a phenomenon known as present bias (which is when savers focus primarily on payoffs in the short-term as opposed to long-term) are key drivers of these approaches. Savers who opt-in are more likely to be financially literate, whereas those who wait for auto-enrollment engage more in present bias.
But there’s one more determinant: how savers perceive the default contribution rate, which is the percentage of employees’ salaries deposited into a retirement plan. Workers who rely on auto-enrollment may stay at the default contribution rate (typically between 1% and 5%), while the ones who are more financially literate and would otherwise opt-in, will increase the default contribution rate, the researchers found.
The researchers also noted that the participants in the study were employed at the U.S. Office of Personnel Management, a federal agency, and were “particularly well-educated and with commensurately high pay.” Thus, results may differ in other employment situations. “That said, our findings suggest that developing ways to mitigate present bias and improve financial literacy may change saving outcomes and ultimately improve welfare,” they said.
Automatic enrollment might have been a blessing in disguise for retirement savers. Thanks to the implementation of work from Richard Thaler, the 2017 recipient of the Nobel Prize in economics, workers may have gained another nearly $30 billion in retirement savings, according to his fellow researcher Shlomo Benartzi. Calculating an exact figure is difficult, but studies show auto-enrollment has either defaulted people into these plans or encouraged employees to ramp up their contributions, which in turn grows their account balances and potential investment returns.
Although auto-enrollment gets people into a retirement account — and any little bit helps — there is a downside. Passive savers are likely to stick to the default contribution rate, but that rate is meant to increase to have enough money come retirement. Default contribution rates should be considered a start, not a suggestion, though many savers don’t react that way.
Money advisor suggest workers stash between 15% and 20% of their salaries for retirement and other financial goals, yet even when default contribution rates are increased, they’re likely hovering below 10%. More than three-quarters of employees would stay in a public-sector supplemental retirement plan if they were automatically-enrolled, and of the 400 surveyed in that report from earlier this year, about half said they would change the default rate — those in the 1% group would increase the amount to an average 5.4% whereas others in the 4% group would increase to an average of 6.6%.
Source: Market Watch
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