A Nobel Laureate Focused on 401(k)s

Congratulations to Professor Richard Thaler, the 2017 Nobel Prize winner in economics.  

Many of us know him through the book he co-wrote with Cass Sunstein, Nudge, which was published in 2008.  Professor Thaler was already famous in our community for highlighting the possibilities where behavioral economic tools and processes could be deployed in retirement savings plans.   With Professor Shlomo Benartzi, he published Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving.  The authors also partnered on “Heuristics and Biases in Retirement Savings Behavior,” published in the Journal of Economic Perspectives—Volume 21, Number 3—Summer 2007.  There they noted, “This strategy, called automatic enrollment (or negative election), has been proven to increase enrollment in U.S. defined contribution plans.” A practical confirmation.    

McDonald's Corp. may have been the first company to implement automatic enrollment in 1984, later to be discontinued citing high administrative expenses resulting from employee turnover.  There were still details that needed ironing out.  

By 1998, only a handful of plans had followed McDonalds lead; regulatory guidance strongly suggested that workers needed to make an affirmative election to defer.  But that year, the Treasury and the IRS issued Revenue Ruling 98-30 providing guidance that clarified automatic enrollment in 401(k) plans was permissible for new hires. This allowed “negative” elections” which were “…made pursuant to an arrangement under which…an employee does not affirmatively elect  to  receive  cash,  (where) the  employee’s  compensation is reduced by a fixed percentage and that amount  is  contributed  on  the  employee’s behalf to the plan.”  Then, in 2000, Treasury and the IRS issued a second ruling which allowed for automatic enrollment for current employees (Rev. Rul. 2000-8).

Just a few years later, The Plan Sponsor Council of America joined with a number of other organizations to encourage Congress to add statutory provisions as part of the Pension Protection Act of 2006.  That law, and subsequent regulations, specifically confirmed that automatic features were permitted and clarified processing (required disclosures, contribution and investment defaults, etc.).

Because of this guidance and because Professor Thaler and Benartzi showed us the way, we now have tens of millions of new participants in retirement savings plans, and trillions of new savings.  ICI reports that we’ve grown from $1.7 Trillion (1985) to $7 Trillion (2016) in defined contribution plan assets! 

We’ve been watching the steady increase in automatic enrollment. According to PSCA’s Annual 401(k) Survey, automatic enrollment grew quickly: adopted by 11% of plans in 2004, 36% in 2007, and 57.5% in 2015. Yet today, six out of seven plans with automatic features limit them to new hires.  So, we still have an opportunity.  If you are thinking about adding automatic enrollment features or if you want to expand existing automatic enrollment processes, consider:  

• Extending automatic features to existing employees, not just new hires, 
• Applying automatic features perennially for those who opt out, 
• Incorporating higher levels of deferral in our default enrollment elections, and/or 
• Deploying automatic escalation so that individuals achieve a higher level of savings and are more likely to be prepared for retirement. 

Thank you again, Professor Thaler.