How automatic saving plans save users twice as much over five years

Abstract

In the last few decades, retirement programs have shifted from being based on mostly employer contributions to mostly employee contributions. As such, millions of people are not properly saving for retirement. They may not know their best savings rate, procrastinate, or fear they can’t afford it.

Thaler and Benartzi utilized behavioral principles to create the Save More Tomorrow (SMarT) program, which increases employees’ annual contribution rate each year (corresponding to a raise) up until a maximum rate has been reached. In this study, the SMarT program has been implemented in three different settings. The first, Plan A, introduced the plan to employees via a one-on-one meeting with a financial planner. The second, Plan B, introduced it via one letter through the mail, and the third, Plan C, executed the program as the automatic option. The most effective method was Plan C, which increased projected savings rates from 5% to 10.9% within five years.

Rating: 5/5 (Significant effects; Easy to implement; Direct positive impact)

How different implementations of the Save More Tomorrow plan increased saving rates
Condition Results
Plan A: employees get a one-on-one meeting with a financial consultant Increased projected savings rate from 5.0% to 9.7% within five years
Plan B: a direct-mail campaign (no personal contact) Increased projected savings rate from 5.0% to 6.1% within five years
Plan C: automatic enrollment Increased projected savings rate from 5.0% to 10.9% within five years 

Key Concepts

Defined-Benefit Savings Plan: A retirement plan in which employers provide guaranteed retirement benefits for their workers. In this type of plan, employees bear the brunt of the savings.

Defined-Contribution Savings Plan: For example, a 401(k) account where employees contribute to their own savings account. The onus of putting money into savings is almost entirely on the employee, although some companies will match a portion of employees’ contributions.

Hyperbolic Discounting: Our preference for choosing immediate rewards instead of future rewards, even if those future rewards are greater.

Status Quo Bias: Our resistance to change and preference for things to say as they are.

Libertarian Paternalism: A school of thought in which it is possible to design programs that guide people to make better choices, but allows them to decide whether or not they want to take part.

The Problem

Defined-contribution plans and hyperbolic discounting

The typical middle-class family accumulates its savings through social security, pensions, and home equity. Over the last few decades, however, pension plans have been leaning away from defined-benefit plans and towards defined-contribution plans that require employees to opt-in and choose how much they want to save. This presents a problem: it can be hard to know how to calculate a household’s proper savings rate, and even if people are able to do this, hyperbolic discounting poses a significant hindrance – they likely prefer immediate satisfaction over delayed gratification. A potential solution to this is hiring a financial advisor; however, they can have a high hourly rate and may not be accessible to people with lower incomes.

Procrastination and the status quo

Procrastination is another roadblock to savings. In 2004, Choi, Laibson, Madrian and Metrick found that “35 percent [of self-reported undersavers] express an intention to increase their savings rate, … but 86 percent … made no changes to their plan four months later.”1 This contributes to the status quo bias, which is rampant throughout retirement savings plans. Savers needed a program that would be accessible to people of varying incomes and that would also be easy to use.

Design

In response to the above barriers, and using concepts from psychology and behavioral economics, researchers Thaler and Benartzi created the Save More Tomorrow (SMarT) program. Employees can commit themselves to increasing their savings rate once a year, coinciding with their annual raise. This program has four main components:

  1. Employers are approached about increasing their savings rates before their scheduled pay increase.
  2. If employees decide to join the program, their contribution plan will increase starting with the first paycheck after an annual raise.
  3. The contribution rate will continue to grow after each scheduled raise until a maximum rate has been achieved.
  4. The worker can opt-out at any time.

The SMarT program has already been implemented in three organizations. 

  1. (Plan A): In 1998, a mid-size manufacturing company adopted the SMarT program as its savings plan at the time had low participation rates. This company hired an investment consultant who offered his services in one-on-one meetings. He proposed the SMarT plan as an alternative to his advice.
  2. (Plan B): Ispat Inland, a large midwestern steel company, approached the researchers about using their plan. Compared to the first organization, this one used minimal resources. There was no financial consultant: employees received one letter that invited them to join the SMarT program.
  3. (Plan C): The final implementation took place at two divisions (Divisions A and O) of Philips Electronics in 2002, and the remaining 28 divisions served as a control. Invitation letters were sent to 815 employees whose savings rates were under 10%. People who enrolled in the SMarT program were told their savings rates would go up in April whether or not they get a raise. Moreover, they were allowed to choose their annual savings increase rates, between 1 and 3%, with the default option being 2%. Everything was done the same at these two divisions except for the following:

Division A

Division O

Participants were given the option of going to a financial education seminar. Participation in the seminar was encouraged.
Participants could not meet one-on-one with a financial planner Participants could meet one-on-one with a certified financial planner.

The CRI2SP framework

While the CrI2SP framework was created by The World Bank in 2016 (twelve years after this study’s publishing), it encapsulates the ways in which Thaler and Benartzi approached the intervention. It stands for Communication, Resources, Incentives and Information, Society, and Psychology, and informs the questions that investigators must ask themselves when conducting a study. Examples of such questions include “How are messages communicated to participants, and are they effective?” “Are resources freely available?”

Results and Application

The results varied by plan. 

  1. (Plan A): The SMarT program was popular with participants: 80% stayed in the plan through four pay raises. Notably, those who decided to enroll in the SMarT program had a much higher savings rate than those who accepted the consultant’s advice (his suggested rates did not increase year after year). 
  2. (Plan B): This program was popular among Ispat Inland employees as well. Of those who were already enrolled in a 401(k) and not yet at their savings maximum, 18.1% joined the plan. Additionally, of those who were not yet enrolled in a 401(k), 8.2% joined. Those who joined had improved their savings rates by about 2%, whereas those who didn’t saw no change in their rates. Notably, few employees dropped out.
  3. (Plan C): As anticipated, there were no significant changes in the savings rates of the remaining 28 divisions of Philips Electronics. The savings rates for those who were already enrolled in a 401(k) and then joined the SMarT plan went up by 1.5%.
Division A Division O
Only 16.9% of this division’s employees joined the program. 38.3% of this division’s employees joined the program.

Using a data set that includes demographic and account data for employees of 15 large companies (539,516 employees), Thaler and Benartzi calculated that each one-percentage point increase of the employee’s savings rate would equate to $250 million in annual contributions in total. If everybody in this sample increased their rate to 5%, that would translate to $125 billion in personal savings per year.

Industry

Application

Development & Social Protection Similar to savings, a SMarT-adjacent program could be created that would increase donation rates to charities each year according to a company’s raise schedule.
Impact Investing & Private Equity E-Trade or similar companies might implement a program that would encourage “set it and forget it” investors to automatically increase their contribution rates each year.
Health & Wellbeing Healthcare is a huge expense, and having a healthy Health Savings Account (HSA) reduces some of this burden. Insurance companies could help their clients by creating a program that would nudge people to increase their savings rates each year.

Ethics

  • The program improves the lives of those involved and is an approachable, accessible savings plan with few barriers to entry.
  • Not much information was given with regard to demographics, so further studies could explore this.
  • Using libertarian paternalism ensures that participants have the freedom to choose which plan is best for them, and demonstrates that the researchers believe in the participants’ ability to decide what’s best for themselves.

Yes

Room for improvement

Insufficient information/Not applicable

Welfare
Does the intervention demonstrably improve the lives of those affected by it? Having a savings account benefits employees and future generations to come.
Does the intervention respect the privacy (including the privacy of identity) of those it affects? The researchers mentioned a few times throughout the study that they do not have demographic or financial information about the employees in their study.
Does the intervention have a plan to monitor the safety, effectiveness, and validity of the intervention? It is not mentioned in the study, however since this was published in 2004 and has since been enacted into law (as part of the U.S. Pension Protection Act in 2006), one can assume that there is or was a plan to do these things.
Autonomy
Does the intervention abide by a reasonable degree of consent? Utilizing a libertarian paternalism approach, researchers allowed participants to opt-out at any time.
Does the intervention respect the ability of those it affects to make their own decisions? It does since participants are able to opt out or change their contribution rates at-will. The authors also mentioned a few times that they want savers to be educated on financial well-being.
Does the intervention increase the number of choices available to those it affects? Yes, it provides another avenue through which employees can create a savings account.
Equity
Does the intervention acknowledge the perspectives, interests, and preferences of everyone it affects, including traditionally marginalized groups? The authors address the multitude of reasons as to why people don’t have a savings account or are resistant to contributing to it.
Are the participants diverse? It’s noted in the study that no demographic information has been taken.
Does the intervention help ensure a just, equitable distribution of welfare? Creating and maintaining a healthy savings account encourages a healthy economy, thus benefiting everyone.

Related TDL Content

Shlomo Benartzi: A co-author of this paper, Dr. Benartzi has contributed to breakthrough work in the field of behavioral economics. Read the article to learn more about how he thinks and the influential findings he’s spent his career pursuing.

Why Optimism is Good for Many Things, But Not Pension Savings: Why do we overestimate our likelihood of success? Optimism bias may be another reason why it’s hard for some people to save for retirement. Read more to hear perspectives on how to become a savvy saver and take advantage of this common bias.

The Unconscious Process Behind Financial Instability: Having a savings account helps promote financial stability at the personal level. But what promotes financial security at the country level? How can we prevent another financial bubble? Professor Selim Aren, a researcher in business administration, sat down with The Decision Lab to answer some of these questions.

Sources

  1. Choi, J., Laibson, D., Madrian, B., & Metrick, A. (2004). For Better or for Worse: Default Effects and 401(k) Savings Behavior. National Bureau of Economic Research. https://doi.org/10.3386/w8651  
  2. Thaler, R. H., & Benartzi, S. (2004). Save More Tomorrow™: Using Behavioral Economics to Increase Employee Saving. Journal of Political Economy, 112(S1). https://doi.org/10.1086/380085