401K Choice Architecture Gone Awry?
One of the most popular examples of choice architecture – how our decisions are influenced by the way options are presented – is the 401K enrollment process. (For non-US Neuromarketing readers, most companies have replaced traditional pension plans with 401K plans. Employees have the option to contribute to an account, the employer matches some or all of the employee’s contributions, and over time the money accumulates. The money belongs to the employee and can be withdrawn at time of retirement, or earlier with penalties.)
401K plans are a great way to accumulate savings, but the problem is that many employees don’t participate. In most cases employees fail to sign up because of inertia – they don’t know how much to contribute, the plan options are full of jargon, there are too many investment choices, etc., so they do nothing. The discipline of choice architecture offered a simple solution: turn the process into an “opt out” decisions rather than “opt in.” That simple change would substantially boost participation, the data showed. US law was changed to allow automatic enrollment.
In an article in the Wall Street Journal, writer Anne Tergeson notes,
But an analysis done for The Wall Street Journal shows about 40% of new hires at companies with automatic enrollments are socking away less money than they would if left to enroll voluntarily, the Employee Benefit Research Institute found. The nonprofit performed a complex computer simulation of savings patterns drawing on data from more than 20 million 401(k) participants.
The news isn’t all bad, of course – more employees are indeed participating, and total amounts saved are higher than before the law was changed to permit opt-out style enrollment. But the study also shows the complexity of predicting human behavior in the real world. It’s doubtful that anyone would have predicted that so many participants would retain the lower default contribution rate vs. a higher self-selected rate.
The proposed solution is yet another tweak in choice architecture: make the default rate higher. Of course, that, too, could have unpredictable consequences. Employees who would have tolerated a lower deduction rate might find a higher rate too onerous and simply opt out rather than scaling back their contributions.
Overall, this is an interesting window into behavior in the laboratory of the real world, using not a few dozen subjects but millions.