Scary study shows 401(k) matching doesn’t work

By Chris Carosa
June 8, 2011
Every 401(k) plan sponsor knows the best way to encourage employee contributions is to offer a match, right? But a recent study suggests this might not be the case. James J. Choi (Yale), David Laibson (Harvard) and Brigitte C. Madrian (Harvard) make this startling argument in their paper “$100 Bills on the Sidewalk: Suboptimal Investment in 401k Plans” to be published in The Review of Economics and Statistics.

This study bears reading. Not only did they find workers ignore the company match, but workers over 59 ½ – who can get this match tax free – might be the worst culprits of all because they should simply know better. Why don’t these employees partake of this clearly advantageous offer? The researchers blamed financial illiteracy and procrastination. They then tested their literacy assumption and found that didn’t work either.

So, two common sense 401(k) plan policies – the employer match and employee education – turn out to be more myth than reality. When asked what policies plan sponsors might adopt to help circumvent this problem, Choi suggested either giving plan participants a firm decision deadline or, more simply, reduce their choices. The more difficult the choice, the more apt the decision maker will push the decision off to another day.

Choi’s analysis affirms earlier studies. Richard Thaler and Cass Sunstein address several fiduciary concerns regarding 401(k) plan enrollment in their 2008 book, Nudge. Using the framework of behavioral economics, the authors both cite exams and offer recommendations that might help 401(k) plan sponsors better help their employees.

The basic notion of Thaler and Sunstein holds will defer making hard decisions – and investing for one’s retirement just happens to be among life’s most difficult decisions for most people. Think about it. To appropriately invest one’s 401(k) assets, the employee must enjoy working on somewhat complicated mathematical scenarios, must have the commitment to faithfully implement any decision and must not be distracted by adult toys, pop culture and screaming kids. Easy, right?

Not so, say Thaler and Sunstein. In fact, the authors feel it’s more reasonable to assume employees more likely will not make the correct decision (we’re not merely talking about what to invest in, we’re talking about savings in the first place). Now consider this. If a plan is designed in a manner that dissuades employees from making correct decisions, and there exists other plan designs that actually encourage employees to make the correct decision, on who’s shoulders does this dereliction of fiduciary duty fall upon? This is why plan sponsors need to pay attention.

The authors suggest two things. First, they whole-heartedly advocate auto-enrollment programs with a limited number of default options – and not necessarily the “balanced” or “target-date” options required by the DOL. Second, they present a program they call the “Save More Tomorrow” program. In it, employees automatically start saving at a small percentage rate of their salary and that percentage increases every time the employee receives a raise.

For example, all employees would be automatically enrolled in a single default investment option – a mutual fund with a goal-oriented target of an 8% average annual long-term return (this would eliminate target-date funds since we’re targeting the return, not the retirement date). The 8 percent target, although it seems high by today’s standards, does reflect a reasonable equity return for a 30-year period (the time period which 20-year olds have until retirement and 65-year olds have as a remaining life expectancy). The 8 percent target also represents the reasonably conservative return requirement to build retirement assets. Remember, we’re only talking about the default option here – employees would always have the option of choosing other options within the plan. Automatic salary deferrals would start at 6 percent (assuming the company matches up to that amount) and 25% of every raise would go towards increasing the deferral rate.

Christopher Carosa, CTFA, is Chief Contributing Editor for

This article originally appeared on the BenefitsPro web site, a Summit Business Media publication.
© 2011 BenefitsPro.