Here's What An Effective Workplace Retirement Plan Looks Like
How to design a retirement plan that actually get's people to save more
A very silly thing that personal finance influencers often tell their audience is that 401ks and other similar workplace retirement plans are a ‘scam.’
They are effective tools to build long-term wealth and fund retirement income needs.
But, not all plans are created equal—some plans and some features of retirement plans are more effective then others.
Today, I will review a research paper that looked at what features of a workplace retirement plan are most effective at getting people to save more money.
How to make retirement saving a little bit easier
Researchers of a 2006 paper titled “Saving for Retirement on the Path of Least Resistance” looked at data from several big companies involving almost 400,000 employees and looked at how people’s savings habits changed when these plan rules changed.
They wanted to see, for example, what happens when a company automatically enrolls its employees in a retirement plan or adjusts the match it offers. The idea was to understand what really gets people to:
Save more
Stick with their savings plans
Retire with enough money to live comfortably
Let's break down the key findings from the research and what they mean for someone thinking about their retirement savings.
If you’ve read the book Nudge, the first thing you probably remember from that book is how powerful the default option is on any decision—especially the decision of whether or not to enroll in a workplace retirement plan.
So, it’s no surprise that this study found that the most powerful feature of a workplace retirement plan is automatic enrollment. If you have to opt out as opposed to opting in to a workplace retirement plan, you are much more likely to start saving and keep saving money.
The study found that when companies automatically sign employees up for a 401(k) plan, participation rates shoot up, especially among younger, lower-paid, and minority employees who might otherwise delay or skip enrolling. Participation rates increased by a whopping 50-67% within six months of starting a new job with an automatic enrollment.
How much of your contributions that your employer matches was the next most important factor. The study found that match thresholds—like contributing 6% of your salary to get the full match—have a big influence on how much people save. People tend to aim for that threshold to maximize the “free money” their employer is offering.
The higher the employer match, the more people are saved—not rocket science, but it very effective.
Speaking of the book ‘nudge,’ I once wrote about a 2021 research paper by Richard Thaller where he and his co-author designed a workplace retirement plan they called the "Save More Tomorrow" plan.
Under the Save More Tomorrow plan, employees commit to increasing their contribution rates automatically whenever they get a raise—which is something I talk a lot about in my book.
This study looked at companies that implement a Save More Tomorrow strategy and found average contribution rates climbed from 3.5% to 11.6% after a few years of enrollment.
That is an absolutely massive increase.
This approach helps people save more without feeling pressure to do it all at once. It allows people to start to slow with what they can afford to save within their budget today and slowly increase their savings over time—and crucially, the timing of those future increases in contributions coincides with their pay raises.
The research also touches on an under-discussed aspect of retirement savings—which is holding onto your savings until you are actually retired.
The study also looked at automatic cash distributions for employees who leave a job with small 401k balances.
It turns out that when people receive these small, automatic payouts, they’re likely to spend the money rather than roll it over into another retirement account, which can really hurt their long-term savings.
The study also looked at the effectiveness of companies providing financial education to their workers.
I was unsurprised that they found that financial education didn’t have much of an impact on worker’s savings habits. I say I was unsurprised because, as I have written about in the past, financial education often doesn’t help people make better financial decisions.
People simply forget what they learn too quickly. For financial education to be most effective, the learning typically needs to happen right before a decision is made. So, if your company is holding a seminar on the pension or 401k plan—it’d probably be best to make any decisions about participating right after the seminar.
Finally, the research touched on eligibility waiting periods and confirmed what I have always felt, which is that they deter people from saving for retirement.
Some companies have a waiting period before you can start contributing to your 401k or pension plan.
The study found that eliminating these waiting periods leads to higher participation rates right off the bat.
In summary, the research highlights that features that make saving easier like automatic enrollment, employer matching, and automatic increases can significantly boost your retirement savings with minimal effort on your part.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.