The views expressed are those of the author as of the date of the article, are for informational purposes only, not meant as investment advice, and are subject to change. Miles Capital does not guarantee the accuracy or completeness of any statements contained in this material and is not obligated to provide updates.
The majority of Americans are headed toward a bleak retirement. According to a research report released last June by the National Institute on Retirement Security, the typical American family has saved only about $3,000 for retirement, and four of five working families have saved less than one times their annual income. As a result, they project the U.S. retirement savings shortfall – i.e., the amount that would be needed to fully fund Americans’ retirement needs – at between $6.8 trillion and $14.0 trillion.
The Employee Benefit Research Institute reported last March that fully 28 percent of Americans had no confidence they would ever have enough money to retire comfortably, the highest level in the study’s 23-year history.
There are lots of reasons for this retirement gap, starting with the shift from employer-managed defined benefit plans to employee-directed 401(k) plans. This, along with long-stagnant family incomes and growing longevity (which increases the ratio of nonworking to working years), has made accumulating sufficient retirement savings ever more challenging.
In the last decade, however, a greater focus on savings behavior has helped to tip the scales toward more robust retirement savings. A 2004 article by Richard Thaler and Shlomo Benartzi described a prescriptive retirement savings program they called Save More Tomorrow, or SMarT. Their plan included four elements: (1) approaching employees about increasing their contributions well before a scheduled pay increase, (2) if the employees agreed, increasing their retirement contribution with the first paycheck after a raise, (3) automatically increasing their contribution rate at each pay-raise, and (4) allowing employees to opt out of the plan at any time. In its initial implementation, 207 employees at a mid-sized manufacturing company were offered the SMarT plan. Of those, 78 percent agreed to participate, 80 percent of participants remained in the plan through the next four pay raises, and the average annual savings rate for participants increased to 13.6 percent compared with 5.9 percent for those who declined. The net result was that those who joined the plan more than tripled their savings rate in 28 months.
Subsequent trials confirmed the positive effect of automatically increasing employee retirements savings contributions, and the Pension Protection Act of 2006 created an attractive path for employers to include auto enrollment provisions, and auto-escalation features into their retirement plans. By removing the need for employees to take action, retirement savings are increased effortlessly, turning what economists call “the status quo bias” in favor of higher savings rates.
In a 2011 paper titled “Increasing Saving Behavior Through Age-Progressed Renderings of the Future Self,” the authors found that people have trouble picturing themselves in their retirement years, and thus save less for their retirement. But when participants in their study used software that turned a current photograph of themselves into one showing how they might look in a few decades, they increased the amount they were willing to save for retirement by 40 percent. In December 2012, Merrill Lynch launched the website faceretirement.merrilledge.com, which allows you to snap your photo and see what you would look like in your retirement. It’s free and worth a try!
More recently, firms like West Des Moines’ own SmartyPig have demonstrated the power of linking goal-setting, rewards for success and a support network to encourage systematic savings. Raise Labs is nearing the launch of a program that will enable students to start earning scholarship dollars as early as ninth grade based on their personal performance and achievements. We expect such efforts to increasingly take hold with employer retirement plans. Although retirement savings will always be bounded at some point by earnings, applying behavioral economics to increasing retirement savings can yield dramatic results.