US workers can thank Nobel winner for future comfort
American workers who have a 401(k) plan at work, all of whom are setting more money aside for retirement than previous generations, may not know that they are doing so because of Richard Thaler.
The Nobel prize for economics tries to recognise important research with far- ranging consequences, but Th aler, awarded the prize on Monday, may well be the first prize winner to have had an almost immediate effect on millions of people’s pay.
Over the last few decades, as more and more American employers killed off their pension plans, workers were offered 401(k)s— or similar retirement plans — with defined contributions instead of defined benefits.
These voluntary accounts should have worked, in theory. Standard economic theory assumes people act rationally: Workers, left to their own devices, should save and invest properly to meet their long-term goals.
However, Th aler and other adherents of behavioural economics pointed out that workers saving for retirement can be their own worst enemies. Without help, Thaler argued, they’ll never retire .“Probably [ behavioural economics’] biggest impact is changing the way retirement plans are run,” said Thaler in a speech at the CFA Institute annual conference in May.
For years, Th aler championed the idea that employees should be “nudged” into joining retirement plans, a concept known as automatic enrolment. Rather than waiting for workers to fill out 401(k) paperwork, employers should automatically sign them up for the plans.
If the employees aren’t interested, they can always opt out.
In a survey by the Plan Sponsor Council of America (PS CA) last year ,58% of plans were automatically signing up workers. That’s up from just 8.1% in 2000.
Th aler didn’ t come up with the idea of automatic enrolment, even if he helped popula rise it in the 2008 bestseller he co- authored with Cass Sunstein, Nudge: Improving Decisions About Health, Wealth, and
Happiness. Thaler did, however, develop the notion of automatic escalation, also called “save more tomorrow”, along with Shlomo Benartzi, a behavioural economist at the University of California at Los Angeles.
The goal ofauto- escalation is to boost how much workers are saving. Setting aside 15% of your salary — an appropriate goal for many middle- and upper-income workers — can feel impossible.
Auto-escalation addresses this by nudging workers to agree to future increases in their savings rates, usually by 1 percentage point each year.
A majority of employers now offer some kind of auto-escalation feature, according to the PS CA, though often workers need to proactively sign up for the option.
Automatic escalation can have a big impact on people’s savings rates — that is according to a recent analysis conducted by David Blanchett, the head of retirement research at Morning star Investment Management.
According to research by Jack VanDerhei — of the US-based Employee Benefit Research Institute — the combination of auto-enrolment and auto- escalation can substantially boost a worker’s chances of retiring with enough income.
In Thaler’ s world of defaults and nudges, much depends on getting the details right. The wrong kind of “nudges” can be destructive. Many companies encourage workers to invest much of their retirement in company stock, something Thaler has argued is too risky for workers.
He also says many companies are encouraging workers to save too little.
“One problem with automatic enrolment is most firms start people out at too low a rate,” he said in his May speech.
Still, the best- designed nudge in the world won’t get somebody to save enough for retirement if that person isn’ t being paid enough. Thaler’s nudges also can’t reach the millions of Americans who don’t have retirement plans at work—at least not yet.
That may change. Several states are setting up automatic individual retirement accounts ( IRAs) aimed at the third of workers who don’t have access to 401(k)s or pensions, and the details of many of those new plans seem ripped from the pages of Thaler’s research.
Oregon, which launches the first auto-IRA programme this month, will start workers out saving 5% of their salaries, unless they choose to object. Their contributions will then auto-escalate every year by 1 percentage point, rising until they hit 10%.
Richard Thaler, economist, Nobel prizewinner: his ‘auto-escalation’ model is seeing some US workers ‘nudge’ an extra 1% contribution into their pension pot each year up to a maximum of 10% of salary.