Nevin E. Adams
Behavioral finance tells us that human beings are prone to relying on heuristics — mental shortcuts, if you will — to solve complex problems. While these may not be very accurate, survey data and anecdotal evidence suggest that participants often rely on these benchmarks.
Here are four that workers use more often than we’d perhaps like to admit.
The Company Match
Survey data and academic research have long suggested a link between the employer match and the level to which workers contribute. Indeed, there has been evidence (frequently invoked by advocates of the so-called “stretch” match) that it’s not the amount of the match that motivates, but the existence of the match at any level.
There is, in fact, evidence that a lot of people save only as much as they need to receive the full employer match (unfortunately, there’s also evidence that many don’t take full advantage — particularly lower income workers — and confusion about how much you need to save to get the full match.
There are, of course, a number of factors that go into determining the amount and level of the match; how much individuals need to set aside for their own personal retirement goals is almost certainly not one of those factors.
Saving to the level of the employer match is certainly a good starting point, but unless it’s truly extraordinary — well, it’s likely not “enough.”
The Automatic Enrollment Default
While you see surveys suggesting that a greater variety of default contribution rates is emerging, the most common rate today — as it was prior to its codification in the Pension Protection Act more than a decade ago — remains 3%. There is some interesting history on how that 3% rate originally came to be (it’s been the standard default for such programs going back to when they were still called “negative elections”), but the reality is that it has become that default because it is widely seen as a rate that is small enough that participants won’t be willing to expend the time and energy to opt out (if they even notice the withholding).
Little wonder that in automatic enrollment plans at Vanguard, more than half (55%) are contributing below the match initially, and one in five (21%) is still below that level after three years.
For those who worry that a higher default would trigger a higher rate of opt-outs, surveys indicate that the “stick” rate with a 6% default is largely identical to 3%. And though there are indications that the default savings rate is moving up from the traditional 3%, there is one thing that you’d like to think everyone knows.
Saving at a 3% rate, unless you have alternate financial resources, is definitely not “enough.”
The Pre-tax Cap
At the height of the Rothification “scare” (and make no mistake, we’re not out of those woods yet), there was a sense that existing automatic enrollment programs might be affected. Specifically, that plan sponsors wouldn’t be comfortable simply continuing to auto-enroll above whatever pre-tax cap was established by legislation ($2,400 was the rumored level at that moment) without some independent approval by the participant (setting aside the irony in turning to an automatically enrolled participant for some direction). Moreover, some providers had echoed that sentiment, saying that they would feel obliged to place that cap in the plans they recordkeep with automatic enrollment provisions — at least until plan sponsors told them otherwise. And if plan sponsors aren’t comfortable making that switch with their automatic enrollment programs — well, you can see how that Roth limit could in short order actually become a limit on retirement savings.
But one of the more unique arguments I heard against Rothification at the time was that that a pre-tax cap, whatever it turned out to be, would be viewed by workers as some kind of de facto sign from the government that the amount they would allow you to save on a pre-tax basis would be seen as a proxy for the “right” amount to save for an adequate retirement.
And just about the time you find yourself thinking, “there’s just no way anybody could be that stupid” – the sad reality sinks in.
In the 2017 edition of the Retirement Confidence Survey, just 4 in 10 workers (41%) report they and/or their spouse have ever tried to calculate how much money they will need to have saved so that they can live comfortably in retirement (the all-time high was 53% in 2000). Not surprisingly, workers reporting that they or their spouse participate in a retirement plan are significantly more likely than those who do not participate in such a plan to have tried a calculation (49% vs. 15%).
Now, over the quarter-century (and change) of its publication by the nonpartisan Employee Benefit Research Institute, the Retirement Confidence Survey has produced any number of interesting, compelling, and even startling findings. And yet, the one that continues to puzzle me is not the percentage of workers who say that they have ever tried to calculate how much they need to save for a comfortable retirement – but the proportion of those who say that evaluation was based on… a guess. That’s not a finding included in this year’s RCS, but in the past, it was as much as 45%.
Several years back, those individuals were asked how much they need to save each year from now until they retire so they can live comfortably in retirement; one in five put that figure at between 20% and 29%, and nearly one-quarter (23%) cited a target of 30% or more. Those targets are larger than one might expect, and larger than the savings reported by RCS respondents would indicate.
All of which brings to mind the following; were the savings projections so high because so many workers didn’t do a savings needs calculation — or did participants avoid doing a savings needs calculation because they thought the results would be too high?
Benchmarks can provide a ready and relevant measure of progress against goals. But if the goal is short of the need, the benchmark may be of little use.
There’s an old saying: “If you don’t know where you’re going, you’ll probably end up somewhere else.” And indeed, for many retirement savers who are relying on unreliable benchmarks, that “somewhere else” could be a pretty unpleasant destination.