How to Increase Retirement Savings

How to Increase


Savings: Key Insights from Behavioral Economics

-By Brad Swain, Common Cents Lab Duke University

The United States is currently under ongoing shift from predictable benefit pension plans to defined contribution plans. Unlike predictable, often mandatory, pension plans, defined contribution plans are often complicated to set up, vary substantially in their design, and must be opted in to in order for employees to start saving.

Somewhat ironically, at about the same time that this shift in retirement strategies started to occur, the field of behavioral economics has shown us that most individuals struggle to make the kinds of decisions necessary to utilize these types of retirement plans effectively.

Fortunately, behavioral economics also provides us with a number of very effective tools for overcoming these barriers to saving. Furthermore, many of these tools have been taken out of academic laboratories and tested in the real world with great success. Here are some guidelines to keep in mind when trying to increase employee buy-in to retirement plans and/or increase contribution to retirement.

1. The Importance of Auto-Enrollment and Auto-Contributions

One of the most common themes in behavioral economics is that people tend to follow the path of least resistance, even if it is not the path that leads to good financial decision making. With that in mind, if we can design products so that people signing up are on the path of least resistance, we can make it much easier for them to participate.

One way to do this is with automatic registration and automatic contributions. A large body of behavioral economics research(1) shows that having employees opt out of retirement accounts instead of opting in greatly increases participation. Similarly, if people are assigned a default level of contribution upon signing up, they are likely to continue contributing at that rate(2).

(1) Behavioral Economics and the Retirement Savings Crisis- Benartzi and Thaler
(2) The Power of Suggestion: Inertia in 401(k) participation and savings behavior – Madrian, Shea

2. Future Commitments

Another key theme in behavioral economics is that the pleasure of now is often more tempting than the pleasure later. It is easier to say you will eat healthy tomorrow than buy a salad today. If that is so, why not commit to salad tomorrow and prepay for it today? The same is true for retirement plans. Behavioral economists call this strategy of getting people to commit now to a future action an “Odysseus Contract”, the name originating from Odysseus willingly tying himself to the boat in anticipation that he will act irrationally when he hears the Siren’s song(1). Getting employees to commit now by contributing more to their retirement plans in the future has been shown to dramatically increase long term retirement savings(2).

(1) Bound to Treatment: The Ulysses Contract – Rebecca Dresser
(2) Save more tomorrow – Benartzi and Thaler

3. Pain of Paying

Not surprisingly, people don’t like seeing their pay check shrink. Even if that money is going somewhere productive, like saving for retirement. Behavioral economists call this the Pain of Paying(1). In a clever study, two behavioral economists were able to avoid the pain of paying by getting employees to commit their future raises to their retirement plans(2). In doing so, employees never saw their pay checks go down and  also made substantial increases in the percentage contributed to their retirement accounts.

(1) Prospect theory: An analysis of decision under risk- Kahneman and Tversky
(2) Save more tomorrow- Benartzi and Thaler

4. Keep Choices Simple

Think about the last time you went to buy toothpaste. Of the dozens of options, do you
know exactly what brand, flavor, and features are right for you? Many people find these kinds of choices overwhelming and often end up making sub-optional choices (or walking away all together!) even when the best option may be staring them in the face. This is called the Paradox of Choice(1). When allowing employees to choose a retirement plan, it may actually be beneficial to restrict the number of choices they can make so that employees don’t feel overwhelmed.

Source:(1) The Architecture of Choice How Much Choice is Too Much? Contributions to 401(k) Retirement Plans – Iyengar, Jiang, and Huberman

More Tools from the Field of Behavioral Economics

This list is just a “greatest hits” of ways that behavioral economics can help employees make better decisions when thinking about retirement. If you want to know more, we recommend the following overview from the U.S. Social Security Administration, Office of Retirement Policy.

The Role of Behavioral Economics and Behavioral Decision Making in Americans’ Retirement Savings Decisions-Melissa A. Z. Knoll