Runs in the Family

Greg Spears

MY 28-YEAR-OLD wanted to know how much to contribute to her retirement plan at work. As a father, this was a text that I loved to get.

In May 2020, we toasted Genevieve over Zoom when she graduated with a master’s degree in social work. Within a week, she’d landed a job helping children in foster care and their families. Now, nearly a year later, she was invited to join the retirement savings plan at work, a 403(b) at her nonprofit agency.

“How much is the match?” I asked her over the telephone.

She texted someone in human resources. “There’s a 100% match on the first 3% and a 50% match on the next 2%,” she said.

“Well,” I said, “if you save 5%, you can give yourself a nice, big raise.”

She decided to go one better, signing up to save 6% of pay, or 10% when you include her employer’s matching contributions. She also contributes annually to a Roth IRA, so her total retirement savings is approaching 20%. She’s also putting away money for a house purchase.

Where does Genevieve come by this saving discipline? We give credit to Charlotte, my late mother. Her well-to-do father—my grandfather—lost everything in the Great Depression. My mother could never shake the fear that the bottom could drop out unexpectedly. She watched her pennies and saved religiously—even during the Blitz in London, when she was with the Red Cross and managed to put some pounds aside.

My mother opened a savings account for me when I was two months old. I still have the passbook with every deposit recorded. Similarly, when Genevieve was young, we made an event of opening her savings account. We chose a bank with a grand marble lobby where a kindly banker welcomed their littlest customer. My mother’s example of savings was passed down in the family.

Most workers Genevieve’s age don’t rush to sign up for a 401(k) plan voluntarily. If you ask them why (as I have) they say retirement is far away and they’ll save for it later. They seem to possess a defective telescope, in the memorable phrase of English economist Arthur Pigou.

“Our telescopic ability is defective and we… see future pleasures, as it were, on a diminished scale,” Pigou wrote in 1920. “This reveals a far-reaching economic disharmony. For it implies that people distribute their resources between the present, the near future, and the remote future on the basis of wholly irrational preference.”

Our preference for the present helps explain the world around us. Kitchens are redone while 529 accounts languish. A professional friend who makes a top income says he’ll work forever, shrugging to signify he is powerless to change his life’s trajectory.

Lots of people could benefit from an intervention when it comes to retirement savings. Happily, behavioral economists invented the automatic enrollment plan for just such a purpose. Rather than waiting for workers to sign up, an employer automatically enrolls new employees in the 401(k) or 403(b) plan. Contributions are invested in a mutual fund that mixes stocks and bonds in amounts judged prudent for the employee’s age. Most employers automatically increase their employees’ savings rate once a year, usually by one percentage point.

Workers can stop contributing whenever they want. Yet relatively few do. Ninety-two percent of employees remain in plans with automatic enrollment, according to 2020 data from Vanguard Group. Only 62% participate in plans if employees need to sign up voluntarily. That big lift, which translates into millions of more savers nationally, was achieved through a couple of insights into human behavior.

First, that “I’ll get to it later” inertia now works in employees’ favor when they’re automatically enrolled. Opting out of the plan would take an effort, however slight. Second, people who aren’t sure how to handle their finances tend to accept their employer’s decisions. It’s a phenomenon known as the endorsement effect.

One problem remains, however. Historically, workers automatically enrolled tend to save less than those who enroll themselves. Why this is so is another example of the endorsement effect, only this time it’s unfortunate.

When the federal government wrote the regulations for the first automatic plans in 1988, it included a hypothetical example. In that example, an imaginary employer set workers’ initial savings rate at 3%. Many employers—anxious to avoid regulatory missteps—took that rate as gospel. Plans with a 3% savings rate predominated for years. It was like filling a swimming pool with just three feet of water—it’s too little for a good swim.

Fund companies such as Fidelity Investments and T. Rowe Price suggest saving at least 15% of pretax pay for retirement, including any employer contributions. Actual savings rates remain stubbornly below that goal. Among retirement plans administered by Vanguard, which suggests saving between 12% and 15%, workers saved 11.1% on average last year, including matching contributions. Close, as they say, but no cigar.

Which is why I loved getting my daughter’s text: “How much should I contribute to the plan?” The answer: More than most people do.

Greg Spears worked as a reporter for the Knight Ridder Washington Bureau and Kiplinger’s Personal Finance magazine. After leaving journalism, he spent 23 years as a senior editor at Vanguard Group on the 401(k) side, where he implored people to save more for retirement. Greg currently teaches behavioral economics at St. Joseph’s University in Philadelphia as an adjunct professor. The subject helps shed light on why so many Americans save less than they might. He is also a Certified Financial Planner certificate holder. Check out Greg’s earlier articles.

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