Advances in behavioural finance and economics have established one thing: people are irrational and tend to make bad choices
, even if they know it’s against their best interests. But workers can benefit from automatic savings programs that consider people’s decision-making behaviour — and that includes several factors.
First, the program needs to have a high-enough initial savings rate. According to a recent Wall Street Journal
article co-written by Nobel laureate Richard Thaler
, employers tend to set low savings rates for their workers’ retirement programs to avoid blowback from employees who want to take home more of their pay cheque. However, studies suggest an initial rate of 7% would be high enough to boost savings without provoking much backlash.
Second, the program should have an automatic escalator which raises savings rates over time to help them set aside enough money for retirement. Ideally, the automatic escalator would be the default option for program members, though it should also be easy for them to opt out.
Third, the savings rate ramp-up should not be stopped too early. According to the Journal
article, nearly half of companies with savings escalators stop at a 6% savings rate, when in fact it should be 10% — and considerably more for those who started late.
Fourth, the authors recommended that savings rates be raised in increments of 2% rather than the commonly used 1%. “[I]t’s an essential feature for those who change jobs frequently, since that typically means starting over at the initial rate,” they said, adding that people have the same reaction to either increase in savings rates.
Fifth, they noted that retirement plans could be more effective if savings rates were increased during significant events, such as Jan. 1 or a worker’s birthday. They could also be introduced at the same time as pay raises to avoid the sting of a smaller pay cheque.
Sixth, a retirement plan should apply to all employees. Instead of introducing it only for new workers, companies should have a periodic “restart” of the program so that everyone can be nudged into checking their saving and investment strategies.
Finally, retirement plans should not be one-size-fits-all. “Retirement plans currently offer all enrolled employees the same recommended savings rate, escalator and cap … but just imagine the possibilities if these plan features were instead personalized to suit the financial needs of the individual,” the authors said.
“If Amazon can personalize shopping recommendations, and Netflix can predict our new favorite show, savings plans ought to be able to come up with personalized nudges.”
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