Let me explain. The underlying logic of automatic enrollment is that humans are prone to decision-making inertia: Once a default setting is established, the evidence suggests they rarely tinker with the details. This inertia can be a good thing, if it encourages people to open new savings accounts. However, the same mental tendency might also lead to serious shortfalls over time, as those automatically enrolled workers will stick with their initial savings rate, even when it's not nearly high enough.
This inertia is only compounded by the fact that the default settings are often seen as implicit endorsements. For instance, employees might assume that 6 percent is the ideal savings rate, though it often takes double that rate to retire comfortably, especially for those who started saving late in their career.
But won't people realize they're not saving enough before it's too late?
Not necessarily. For the last several years, Dan Goldstein, principal researcher, Microsoft Research, a wholly owned unit of Microsoft Corp., and honorary research fellow at the London Business School; Hal E. Hershfield, assistant professor of marketing, Stern School of Business, New York University; and I have been studying a behavioral tendency known as the illusion of wealth.
In essence, the illusion of wealth has to do with the fact that a significant lump-sum amount of money—say, $100,000 in a savings account—seems like far more money than it actually is, at least when we're forced to live off it in retirement. The end result is that workers might conclude they are saving enough for retirement, when the reality is they are falling far short. If that's the case, then IRAs might come to stand for illusionary retirement accounts. They give us the illusion of security, but not the real thing.
What's the solution? We need to combine auto enrollment with auto escalation so that savings rates are gradually raised over time. (Workers, of course, can always opt out of the program.) In a 2004 study I co-authored with Richard H. Thaler—Charles R. Walgreen distinguished service professor of behavioral science and economics, University of Chicago Booth School of Business—we demonstrated that auto escalation was able to take the savings rate at a midsize manufacturing company to 13.6 percent from 3.5 percent in less than four years.
In the years since, auto escalation has become a popular and effective savings tool, offered by more than half of all large corporations in the U.S., and it has helped doubling the saving rates of more than 4 million employees. It's time to make the same benefits available for the small employers and part-time workers most likely to rely on MyRAs. Under such a system, IRAs would become synonymous with automatically increasing retirement accounts.
Millions of people have benefited from the insights of behavioral economics as applied to retirement savings. We've learned that, when it comes to saving, it's really important to make things as easy as possible, which is why auto enrollment is so effective.
But making it easy to save is just the start. If we are serious about fixing the retirement crisis, then we also need to make it easy to save enough.
Shlomo Benartzi is professor and co-chair of the behavioral decision-making group at the Anderson School of Management, University of California, Los Angeles, and chief behavioral economist of the Allianz Global Investors Center for Behavioral Finance, which seeks to turn academic ideas into a practical tools plan executives can use to help participants make better financial decisions. He wrote this for Crain's Pensions & Investments magazine, a New York City-based sister publication of Tire Business.