How Do Consumers Respond When Default Options Push the Envelope?
Automatic enrollment and default contribution rates have been shown to increase participation in 401(k) pension plans, leading to an increase in retirement savings. In the US, approximately half of employees use automatic enrollment. 40% of these employers offer 3% as their default contribution rate, 20% offer 6% as default, and only 2.4% offer a default contribution rate greater than 6%.
This, however, may still not be enough to reach sufficient retirement savings. According to Laibson (2012), the average US employee will receive only 50% of pre-retirement income, given current rates of saving. Can offering higher default contribution rates help to increase savings rates, or would this backfire as participants simply opt out of plans altogether?
Beshears, Benartzi, Mason and Milkman (2017) ran a field experiment with employees of Voya Financial’s clients. On the website to enroll in workplace pension plans, different suggested contribution rates were assigned to employees randomly, ranging from 6% to 11%. Employees could select a preferred contribution rate or opt out of the plan.
Employees who were suggested a contribution rate greater than 6% were more likely to choose higher contribution rates. The average increase was 20-50 basis points, compared to a baseline rate of 6.11%. The display rates higher than 6% all led to an average contribution rate that is statistically significantly higher than the one of the 6% display rate. It was noted that the average contribution rates of the 7% to 11% group did not vary significantly. Interestingly, employees who were shown a contribution rate between 7% and 10% did not opt out any more often than employees of the 6% contribution rate. Employees in the 11% group, however, were more likely to opt out (by 3.7 percentage points).
Generally, for an employee with an annual salary of $70,000 who contributes for 40 years and earns an annual rate of return of 6%, the incremental increase of 20-50 basis points would result in additional savings worth $23,000-$57,000.
Display rates higher than 6% are able to increase the average contribution rates to pension plans significantly. While the display rates studied are not exactly the same as automatic enrolment default contribution rates, the authors of this study find that the study of display rates is informative about the two main concerns against higher default rates:
- Employees seemed to consider costs as well as benefits of selecting higher display rates. This is shown by the observation that contribution rates remained steady among the higher display rates.
- Employees with higher display rates were not necessarily more likely to opt out – this only occurred in the group with the highest display rate.