Russell Sage Behavioral Economics Summer Institute, 2002 Russell Sage Behavioral Economics Summer Institute, 2002 Savings Decisions, Savings Defaults, and Savings Outcomes by Brigitte Madrian 1
References References 2
References References � The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior, Madrian and Shea (2001) � For Better of Worse: Default Effects and 401(k) Savings Behavior, Choi, Laibson, Madrian and Metrick (2001) � Defined Contribution Pensions: Plan Rules, Participant Choices, and the Path of Least Resistance, Choi, Laibson, Madrian and Metrick (2002) � Benign Paternalism and Active Decisions, Choi, Laibson, Madrian and Metrick (2002) 3
Overview Overview 4
Overview Overview � 401(k) Primer � Evidence on default effects in 401(k) savings plans – Automatic enrollment – Automatic cash distributions – Matches in company stock � Explanations—standard and behavioral � Preferences vs. procrastination for delayed 401(k) enrollment � Conclusions: promoting savings behavior through plan design 5
Automatic Enrollment Automatic Enrollment 6
401(k) Primer 401(k) Primer � Voluntary employer-sponsored defined contribution savings plan � Limited government regulation – Some impact on employer decisions vis-à-vis plan design – Limits on maximum savings contributions—non-binding for vast majority of employees � Substantial variation in plan design across firms – Plan design endogenous to the firm – From the employee’s perspective, plan design could be taken as exogenous – From the employee’s perspective, changes in plan design almost surely exogenous � “Typical” 401(k) plan 7
Automatic Enrollment Primer Automatic Enrollment Primer � How does automatic enrollment work? � Why do companies adopt automatic enrollment? � How do companies implement automatic enrollment? � Treasury/DOL rulings 8
Default Contribution Rates and Investment Funds Default Contribution Rates and Investment Funds in Companies with Automatic Enrollment in Companies with Automatic Enrollment 70% 70% 60% 60% 60% F ra c tio n o f P la n s F ra c tio n o f P la n s 46% 50% 50% 40% 40% 30% 30% 21% 21% 16% 20% 20% 12% 12% 8% 10% 10% 4% 0% 0% 0% 0% Stable MM Balance Life Stock 1% 2% 3% 4% 5% 6% Value Default Contribution Rate Default Investment Fund 9
The Effects of Automatic Enrollment The Effects of Automatic Enrollment in Theory in Theory 10
The Effects of Automatic Enrollment in Theory The Effects of Automatic Enrollment in Theory � View 1: Automatic enrollment doesn’t change the economic fundamentals of the planning problem � automatic enrollment should not influence savings outcomes � View 2: Automatic enrollment manipulates the way the savings decision is framed � automatic enrollment can impact savings outcomes 11
Data Data 12
Automatic Enrollment in Three Companies Automatic Enrollment in Three Companies Company A Company B Company C Industry Office Equipment Health Insurance Food Date January 1997 April 1998 A) January 1998 implemented B) November 1999 Employees Hired 01/1997+ Hired 04/1998 + A) Eligible 01/1998+ affected B) Not participating and eligible before 01/1998 Opt-out period 60 days 30 days 30 days Default rate 2% 3% 3% Default fund Stable value Money market Stable value 401(k) match 67% up to 6% of pay 50% up to 6% of pay 50% up to 6% of pay Other changes Investment funds 1-year to immediate 1-year to immediate eligibility eligibility if age<40 13
Identifying the Effects of Identifying the Effects of Automatic Enrollment Automatic Enrollment 14
Indentifying the Effects of Automatic Enrollment Indentifying the Effects of Automatic Enrollment � Strategy: Compare the 401(k) savings outcomes of employees who were hired before and after automatic enrollment at equivalent levels of tenure � Note: Controlling for tenure is important—401(k) savings outcomes impacted by tenure 15
The Effects of Automatic Enrollment The Effects of Automatic Enrollment in Practice in Practice 16
The Effects of Automatic Enrollment in Practice: The Effects of Automatic Enrollment in Practice: 401(k) Participation 401(k) Participation � Dramatic increase in 401(k) participation rates � Biggest increases for – Low tenure employees – Young employees – Lower paid employees – Black and hispanic employees 17
401(k) Participation by Tenure: Company A 100% Fraction ever 80% participated 60% 40% 20% 0% 0 6 12 18 24 30 36 42 48 Tenure (months) Hired after AE Hired before AE 18
401(k) Participation by Tenure for Employees Aged 40+ at Hire: Company C 100% 80% Fraction ever participated 60% 40% 20% 0% 0 6 12 18 24 30 36 Tenure (months) Hired after AE Hired before AE and observed before AE 19
401(k) Participation by Tenure for Employees Aged 40+ at Hire: Company C 100% F ra c tio n e v e r p a rtic ip a te d 80% 60% 40% 20% 0% 0 6 12 18 24 30 36 42 48 54 Tenure (months) Hired before AE and observed after AE Hired before AE and observed before AE 20
The Effect of Automatic Enrollment on 401(k) The Effect of Automatic Enrollment on 401(k) Participation by Demographic Characteristics Participation by Demographic Characteristics 100 100 88 86 86 85 81 75 80 80 60 60 46 42 43 36 40 40 22 19 20 20 0 0 Male Female White Black Hispanic Other Gender Race/Ethnicity 95 94 93 92 100 100 92 90 90 89 86 86 83 83 80 80 80 68 62 60 60 58 60 51 60 52 47 42 37 40 40 25 25 13 20 20 0 0 <$20K $20- $30- $40- $50- $60- $70- $80K+ 20-29 30-39 40-49 50-59 60-64 $29K $39K $49K $59K $69K $79K Age Annual Pay 21
The Effects of Automatic Enrollment in Practice: The Effects of Automatic Enrollment in Practice: 401(k) Contribution Rate 401(k) Contribution Rate � Substantial fraction of participants under automatic enrollment contribute at the default deferral rate – Induced participants: non-participation � default rate – Would-be participants: higher rate � default rate � Fraction of participants at the default rate decreases with tenure 22
401(k) Contribution Rates by Tenure: Company A 80 Participants Fraction of 60 48 36 40 24 17 16 15 20 11 10 9 8 4 2 0 1% 2% 3-5% 6% 7-10% 11-16% Contribution Rate Hired before AE Hired after AE 23
401(k) Contribution Rates by Tenure: Company A 80 57 Fraction of Participants 60 48 36 40 24 17 16 15 20 11 10 10 9 9 8 7 5 4 2 2 0 1% 2% 3-5% 6% 7-10% 11-16% Contribution Rate Hired before AE Hired Under AE Hired after AE 24
401(k) Contribution Rates for Participants with Equivalent Tenure: Company B 76 80 Fraction of Participants 60 40 30 20 18 20 12 12 8 8 7 6 2 2 0 1-2% 3% 4-5% 6% 7-10% 11-15% 401(k) Contribution Rate Hired before AE Hired after AE 25
401(k) Contribution Rates for Employees with Equivalent Tenure: Company B 80 65 63 Fraction of Employees 60 40 14 20 11 7 7 7 6 5 4 4 3 2 1 0 0% 1-2% 3% 4-5% 6% 7-10% 11-15% 401(k) Contribution Rate Hired before AE Hired after AE 26
The Effect of Automatic Enrollment on 401(k) The Effect of Automatic Enrollment on 401(k) Contribution Rates by Demographic Characteristics Contribution Rates by Demographic Characteristics 10 10 8.9 7.5 7.6 8 8 7.1 6.8 6 6 5 5 4.9 4.7 4.2 3.7 3.3 4 4 2 2 0 0 White Black Hispanic Other Male Female Race/Ethnicity Gender 10 9.5 10 10 8.8 8.8 8.7 8.3 8 7.7 7.6 8 8 7.1 7.1 6.9 6.9 6.6 6.3 6.2 6 5.5 5.4 5.2 6 6 4.9 4.6 4.4 3.8 3.5 3.4 4 4 2 2 0 0 <$20K $20- $30- $40- $50- $60- $70- $80K+ 20-29 30-39 40-49 50-59 60-64 $29K $39K $49K $59K $69K $79K Age Annual Pay 27
Accounting for Demographic Characteristics in Accounting for Demographic Characteristics in Assessing the Impact of Automatic Enrollment Assessing the Impact of Automatic Enrollment Difference in savings outcomes for employees hired after vs. before automatic enrollment for employees with tenure of 3-15 months (Company B) 401(k) 401(k) Participation Contribution Rate Rate Raw difference +48.5% -2.9% Regression-adjusted +50.4% -2.2% difference 28
The Effects of Automatic Enrollment in Practice: The Effects of Automatic Enrollment in Practice: Asset Allocation Asset Allocation � Substantial fraction of participants under automatic enrollment have assets entirely allocated to the default fund – Induced participants: non-participation � default fund – Would-be participants: other allocation � default fund � Fraction of participants with assets wholly allocated to the default fund decreases with tenure 29
Asset Allocation of 401(k) Participants: Company B Fraction of Total 401(k) 100% 8 19 80% Money market Assets 60% 81 Bonds 40% 73 Stocks 20% 3 16 0% Hired before Hired after AE AE 30
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