Saturday, May 05, 2007

Attention Deficit Disorder


We have long been concerned about the attention deficit of participants when it comes to their 401(k) plans. There’s the problem of getting them to pay attention to the importance of saving in the first place, and of choosing an appropriate level of savings, the challenge of helping them make sound investment decisions—and the biggest challenge of all, getting them to reconsider those choices over time. Our continued inability as an industry (I realize there are pockets of exception to this rule) to fully engage participants on the issue has, ultimately, led to the adoption of automatic plan designs that don’t require the participant to “do” anything other than write the check.

I have a more radical solution to the problem: Let’s make people sign up for their 401(k)—every year.

Before you spit up your morning beverage (apologies if it’s too late for that), hear me out. I will concede that signing up for a 401(k) plan can be a daunting task for a participant, and that it is already logistically challenging for employers (and advisers) to accommodate annual meetings for new workers. But consider this: Is it any more onerous than the annual decision(s) attendant with health-care plan enrollment?

Starting Blocks?

In many ways, the “automatic” solutions are a band-aid, at best. The Pension Protection Act’s automatic enrollment safe harbor requires only a 3% contribution from workers who don’t contribute actively, and steps that up by only 1% a year, and then only until it reaches 6%. That’s where many participants start contributing today, of course—and don’t tell me that an automatic enrollment program won’t turn some (perhaps many?) who today take the time to fill out the forms into defaulted savers in the future. Ironically, the PPA could actually serve to reduce some deferral rates, left unattended (see “Starting Blocks”).

Think those target-date fund defaults will fix poor asset allocation decisions? Perhaps for those that adopt them—but many (most?) plan sponsors seem only to be interested in adopting the change prospectively, doing nothing for those who are already enrolled in the plan. And the PPA’s safe harbor only requires prospective adoption for the automatic enrollment provisions.

Still, even if the PPA’s automatic solutions aren’t a perfect solution, even if they require some implementation oversight, why would I suggest that we make participants (and employers) undertake the painful process of enrollment every year?

I have long thought that the concept of saving for an ambiguous goal like “retirement” was just beyond the short-term comprehension of most people. Just about everything else we focus on has a much shorter term—we have annual budgets, monthly expenses, weekly meetings. Additionally, saving for retirement has largely been presented as something you need to do - - - someday. Most plans don’t allow for immediate eligibility (I appreciate the administrative rationale for some high-turnover workforces), and the vast majority of programs don’t even require that the 401(k) enrollment form be returned, much less completed (see “Participant Directives”). Contrast that with your workplace health-care program—the one you have to choose every year, and return the form—or have a program chosen for you.

Decision Points

Still, to say that an annual 401(k) enrollment is no more painful than health-care enrollment is not to say that it wouldn’t be painful. However, IMHO, an annual enrollment process could well lead to better decisions with these programs. Vanguard published a study on Roth 401(k) enrollment this week—and they found that the strongest correlating factor with participants choosing the Roth was being a new employee (see “Early Roth Adopters Are Active Retirement Savers”). This single attribute increased the probability of adoption by 3.2 percentage points on top of the normal 5% adoption rate—an increase of about 65%. Are these new workers smarter? I doubt it. Younger (and thus more likely to be enamored of the tax benefits of the Roth)? Perhaps, but age, while a factor, wasn’t the determinative factor—tenure was. Moreover, this result corresponded with the findings of another survey (also done by Vanguard) a couple of years ago that found some significant differences in asset-allocation choices—depending on when you joined the plan. These studies—and any number of others—suggest that, once most workers are “in,” they’re “done” making informed decisions about their retirement savings; the amount, the investment, the type. But they also suggest that, at the point of enrollment, participants are paying attention and are, in the aggregate at least, making decisions that seem reasonably informed.

Ironically, IMHO, the current solutions touted for engaging participants more seem mostly to rely on involving them less. That may be what they want—but I’m not convinced it’s what they need.

- Nevin Adams

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