Maximizing workplace retirement plans

Defaults and investment decisions

When participants are enrolled automatically in workplace retirement plans, their contributions need a place to go. Typically contributions are defaulted to target-date funds or life-cycle funds, as allowed by the guidelines in the Pension Protection Act.

This can be a double-edged sword as the "fund of funds" structure of target-date and life-cycle funds can be expensive.

Expense ratios for the category range from 0.18 percent to 1.68 percent, with an average asset-weighted expense ratio of 1.02 percent, according to Morningstar.

Once participants are automatically enrolled into default investments, they're much more likely to stay there, according to the National Bureau of Economic Research.

One possible explanation for the reluctance to move away from default investments could be the number of choices and the complexity of the decision. Research has found that it's harder to choose from lots of things rather than a few things.

"People like me who come from the behavioral side say, 'Well, choice is not that great for the people they are supposedly helping.' You are actually going to make people better off by not having those choices," says Statman.

In three experiments involving jams, chocolates and extra-credit essays, researchers Sheena Iyengar, from Columbia Business School, and Mark Lepper, from Stanford University, found that while having many choices seemed appealing initially, too many choices could weaken motivation as well as later satisfaction.

In concluding the study, released in 2000, Iyengar and Lepper hypothesized that though people enjoy choosing, they find the responsibility of separating good choices from bad to be something of a burden.

That's easy to imagine when it comes to making retirement decisions and facing the responsibility of choosing good investments from an array of complex options.

Paternalism vs. shaping behavior

Not all employers want to add automatic features to workplace retirement plans. They can still lure employees to save for retirement using the employer match option.

The design of the match formula can make a big difference, says Marcy Supovitz, president of the National Association of Plan Advisors.

"If a plan offers a match of dollar for dollar for the first 3 percent deferred, the vast majority of employees defer only 3 percent. If you take the same match and instead do 50 cents on the dollar on the first 6 percent deferred, then the vast majority of employees will do 6 percent," she says.

The Department of Labor is currently investigating the possibility of automating the withdrawal process at retirement, which could come with another set of benefits and pitfalls for individuals.

Similar to buying health and car insurance, saving for retirement is an individual choice that has wider ramifications. Despite the premium placed on individual choice, the government and employers may be increasingly stepping in to shape people to behave rationally when it comes to saving and investing --instead of behaving illogically, like people.


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