Simplicity doesn’t boost 401(k) participation

NEWSWISE-While the average American life expectancy is 76 for men and 81 for women, many people retire at age 62. That means by the time people stop working, they need to have enough money saved up to live on for the rest of their lives, which could be 15 to 20 years or longer.

Despite such statistics, many people aren't making good decisions in retirement planning, says Charlene Kalenkoski, director of the Retirement Planning and Living Research Initiative in the Texas Tech University Department of Personal Financial Planning.

Perhaps surprisingly, that's not because the information is too complex, Kalenkoski claims.

In a new study using a hypothetical employer-sponsored 401(k) plan, Kalenkosi's research team examined how the presentation of financial planning information impacts retirement-savings behavior. Contrary to their expectations, they found that simplifying the information did not increase plan enrollment rates among two groups studied-new employees earning more than $50,000 and business school students.

"Defined benefit plans have largely given way to defined contribution plans, putting most Americans in charge of saving for their own retirement," Kalenkoski says. "However, many Americans are financially illiterate and are saving way too little for retirement."

The goal of the research was to investigate whether simplifying retirement plan information provided by employers would encourage employees to participate in retirement plans and to make good decisions regarding how much to contribute and how to invest those contributions, she says.

"The idea behind our study was that people starting a new job are given a lot of information and a short amount of time to make important retirement decisions. We thought that by streamlining the information and making it easier to understand, people would be more inclined to enroll. This was not the case," - Kalenkoski says.

Other studies, however, have shown that having enrollment as the default and forcing people to opt out increases participation, she says.

"It appears that people just don't want to take action. They don't want to tie up money," Kalenkoski says.

In addition to participation rates, the study also addresses the more important concepts of choosing contribution rates and making investment choices.

"Even people who make the wise decision to enroll make bad choices here," Kalenkoski says. "Some people naively invest by dividing their contribution up to invest in all choices. That is not good diversification and leads to lower returns on their investment."

Some people choose the employer's default, which may be a money market fund, she says, adding, "You don't earn enough of a return on that to end up with a decent retirement account."

Some people just choose company stock, which is not diversifying at all, she asserts. "If the company goes under, you not only lose your job but also your retirement account. People make all sorts of bad choices because they do not know what good choices are."

One of the mistakes Kalenkoski identified is when people don't take full advantage of employer-sponsored match programs.

"After a person has decided to enroll, they need to know what percentage of their salary they would like to contribute," she says. "Usually they get a full match from the employer up to a certain percentage, say 4 percent. That means if they put in 4 percent, their employer will also contribute 4 percent. Some people don't take full advantage of this match. Suppose they only contribute 2 percent. Well, yes, they are not contributing an additional 2 percent themselves, but they are also not getting that additional 2 percent from their employer, so they're giving up free money."

To improve people's contribution rates and investment choices, an implication of this and other studies is to set these rates and investment choices higher than people are currently choosing, she says. "However, this is not ideal, as what is optimal should differ across individuals based on their individual situations."

The next step in Kalenkoski's research will focus on default contribution rates. She particularly wants to explore how high rates must be for people to begin choosing their own rates.