Making Good Choices (Winter 05-06 Trust Magazine article)

  • February 03, 2006
  • By Tim Gray

The Retirement Security Project has common-sense ideas to help workers build a nest egg for the future.

This H&R Block office in the St. Louis suburbs, just north of the city line, seems an unlikely site for an economic experiment. The shopping center where it's located, snug against busy Natural Bridge Road, houses a grocery, a sub shop, a bowling alley and a smattering of small stores that cater to the residents of this workingclass neighborhood.

The H&R Block office itself, with its cubicles, computers and lime-green and gray décor, could pass for a travel agency except that posters touting destinations like Aruba and the British Virgin Islands have been replaced by ones imploring customers to open an Express IRA.

But here—and in 59 other offices in and around St. Louis—the taxpreparation company teamed up with the Trusts-initiated Retirement Security Project (RSP) earlier this year to determine whether moderate- and lower-income workers could be induced to save money.

H&R Block matched the contributions of people who agreed to set up individual retirement accounts. The company put up the funds—a total of $500,000—and a group of economists recruited by RSP designed an experiment that would withstand the scrutiny of their peers. During tax season, H&R Block tax preparers offered some randomly selected customers matches of 20 percent or 50 percent if they opened an IRA.

The results silenced the skeptics. When enticed with matching funds, workers saved more, and the more they were offered, the more they saved.

Conventional wisdom claimed that even incentives would not change the savings patterns of moderate- and lower-income Americans. The experiment, however, is “empirical evidence” of the opposite, according to Peter R. Orszag, Ph.D., RSP's director. To maximize effectiveness, the match must be clear and understandable, the savings vehicles must be easily accessible, and professional assistance should be available to advise potential savers.

With this research and analysis in hand, RSP aims to help inform policy to make it more effective in encouraging savings.

In partnership with Georgetown University's Public Policy Institute and the Brookings Institution, the two-year, $3.9-million project is, in effect, trying to replicate around the country what was achieved in St. Louis. Backed by an advisory board that includes members of five presidential administrations (see "Experience and Expertise at the Helm" below), RSP is looking for practical, commonsense ways to both prompt people to save more and identify incentives to saving embedded in government programs and policies.

The project originated in discussions between Orszag and Health and Human Services staff at the Trusts about policies that might help America grapple with the problem of an aging population. “We wrote a paper called ‘Aging in America,'” Orszag says. “Out of that came retirement savings and long-term care as pressing issues.”

And the idea for RSP sprang from the discussions that followed. It is an attempt to address what Orszag sees as an imbalance in Washington policy debates about retirement saving. “You have pension lobbyists who are interested in an approach that doesn't always benefit middle- and lowerincome earners,” he explains. “And you have academics who are interested in helping less affluent people but have no real way of influencing the debate. And there was growing evidence about reforms that could work.”

RSP's premise is that Americans need help saving. The average U.S. household puts away about 2 percent of its income, compared with 5 percent for the average Japanese household and 10 percent for the average European household, according to a study by the Organization of Economic Co-operation and Development.

The average Social Security benefit is just over $10,000 a year, and although most Americans know that Social Security will not be enough to live on, many do not have much more than that. In fact, the median retirement savings in a 401(k)-type plan or individual retirement account in households approaching retirement age (from 55 to 59) is about $10,400, according to the Survey of Consumer Finances. The median for those with incomes less than $30,000 is zero.

Some might say, “So what?” After all, this country's economy remains the largest in the world.

But by failing to save, Americans imperil both their personal welfare and the economy's future health, says William G. Gale, Ph.D., a principal at RSP and a senior fellow at the Brookings Institution.

“At the individual level, the costs are direct. If you don't save, you miss opportunities to buy a house, go to college or get a car to drive to work. At the societal level, the costs are subtler, but just as real. The less that we save as a country, the less we have to invest. Just like a family that saves less has less future income, a country that saves less will invest less and have less future income.”

For much of the 20th century, Social Security and employer-provided pensions served Americans, including those who failed to save money in personal accounts. But that safety net has begun to fray. Social Security, of course, is caught in a political scrum, but there is general agreement that something must be done to shore up its finances.

Even more crucial for RSP's focus is the decline of traditional pensions, or “defined-benefit plans,” in which employers make contributions on the employee's behalf and manage the money. “There have been no new defined-benefit plans started in the last 15 or 20 years,” says Brigitte Madrian, Ph.D., the Boettner Associate Professor in Financial Gerontology at the University of Pennsylvania's Wharton School. (Her research has informed RSP's policy recommendations.)

In their place are 401(k)-style plans, called “defined-contribution plans,” with employees choosing how much to invest and where to invest it. Today, defined-benefit plans cover about 20 percent of private-sector workers, while defined-contribution plans cover 35 percent. Some people have both.

With Social Security payments unlikely to become more generous and a loss of old-style pensions, Americans will either have to save more or face the possibility of an impoverished retirement.

Enter RSP into the discussion. Working with the Trusts' staff, Orszag and his team have developed a four-point plan to help ensure that middle- and lower-income Americans don't end up with less than they need in retirement. RSP aims to:

  • Encourage employers to automatically enroll employees in retirement plans unless the worker turns down the offer. In most current plans, employees have to elect to participate.
  • Persuade the Internal Revenue Service to allow split tax refunds, depositing part in the taxpayer's retirement account and part in a checking account. This would make it easier for people to save at least some of their check from Uncle Sam.
  • Make the case for broadening a tax credit for retirement contributions by middle- and lower-income people.
  • Persuade federal agencies to relax restrictions on the amount of retirement savings people can have without threatening their eligibility for public assistance programs like food stamps and Medicaid. Under the current, 30-year-old rules, anything more than a modest nest egg disqualifies someone who has shown enough motivation to save.

RSP's research-based recommendations are already having an impact on the debate. Robert Greenstein, executive director of the Center on Budget and Policy Priorities, which has been called “socially liberal, fiscally conservative and academically rigorous,” says: “As someone who's been in Washington for 33 years, this is one of the most rapid cases of the emergence of a new project as a central player in a policy debate that I've seen.

“The concept of making changes in federal policy to move pension plans to automatic enrollment was barely a part of the discussion a year ago. Now we have the White House and the chairmen of the House Ways and Means and Senate Finance committees indicating that it's a good idea and should be done. That's a massive impact.”

And John Goodman, president of the National Center for Policy Analysis, which “encourages individual rights, free enterprise and self-government,” teamed up with Orszag to brief members of Congress on the benefits of automatic 401(k) enrollment. “Typically in a Capitol Hill briefing, there's somebody stepping forward to say something negative, but this was a love fest,” Goodman says, noting that there was broad bipartisan support for the idea.

Says Maureen K. Byrnes, director of Policy Initiatives and Health and Human Services at the Trusts: “RSP's experience underscores that it is possible to earn bipartisan interest and support if one focuses on a compelling issue at the right time, with the right partners and with solid research that points to practical solutions.”

Vicki Blanton sees first-hand the difficulties that working people face in trying to save. A lawyer at the J.C. Penney Company in Plano, Texas, she oversees the legal aspects of the pension plan intended for the company's 151,000 employees, many of them retail clerks making relatively modest wages. RSP invited her to speak at its launch forum in March. Networking with practitioners like Blanton is central to how RSP learns what works, Orszag says. “We have a substantial corporateoutreach component. That helps us inform policy.”

What's more, J.C. Penney has the sort of common-sense retirement plan that RSP is encouraging more employers to offer, because it makes saving easier and more significant.

In 1997, J.C. Penney had decided to nudge its employees toward saving more by adopting an automatic-enrollment 401(k) plan. After employees work for the retailer for a year, they are enrolled in the plan unless they ask not to be. After the change, participation in the 401(k) shot up from 71 percent of eligible employees to 85 percent, Blanton says, “and we've been able to keep it at that level.”

At first, J.C. Penney put 2 percent of an employee's after-tax wages in the plan, though employees could contribute more. In 1999, the retailer raised the automatic contribution to 3 percent. This year, it bumped it to 4 percent and changed from after-tax to before-tax dollars. The change means that, for every $100 of wages, an employee can save an extra dollar yet reduce take-home pay by less than a dollar.

Today, J.C. Penney employees have an array of mutual funds in which they can invest their 401(k) contributions, Blanton says. If they don't make a choice, the company deposits their money in a stable value fund. Employees won't lose money in that fund—J.C. Penney didn't want to expose itself to the legal liability if employees lost their principal—but their investments won't grow as rapidly as they could in a portfolio of stocks or one of stocks and bonds.

To help employees make investment choices, J.C. Penney in 2003 hired Financial Engines in Palo Alto, Calif. At no charge to employees, Financial Engines provides online investment advice and education. For an additional fee, the firm handles employees' investments for them by picking their mutual funds, reviewing investment performance and rebalancing when necessary.

Employees do nothing besides elect the service. “It's for reluctant investors, typically people who've accepted the default election,” says Christopher Jones, a Financial Engines executive vice president. “They're either too intimidated or too busy to deal with their investments.”

RSP would like to see more employers follow J.C. Penney's lead and provide access to financial education and advice. Too often, even good plans and generous matching contributions leave employees floundering when it comes to picking investments because, in theory, the right mix of stocks and bonds varies from person to person.

“The important point is to not let the perfect be the enemy of the good,” RSP's Gale says. “It's difficult to know what the exact, right asset allocation is for any one employee. But it's not difficult to know that sticking it all in money-market funds or company stock is a bad idea. Just moving into broad stock-market portfolios is a big help.”

Automatic enrollment plans like J.C. Penney's aren't just a perk for employees, Orszag points out. They have practical benefits for employers, too: The more money a pension plan contains, the more efficiently it can be run. Larger plans, for example, can receive better deals on brokerage commissions and money-management fees, and a larger plan's fee represents a smaller percentage of its total assets.

Just as important, the IRS and the U.S. Labor Department look more favorably on plans with high levels of employee participation, Orszag says. Plans that don't meet required participation levels may violate tax laws.

Many of the insights underpinning RSP's encouragement of automatic enrollment—and, for that matter, plans like J.C. Penney's— have sprung from a relatively new field in the social sciences called behavioral economics.

Behavioral economists don't believe the traditional economic orthodoxy that people unrelentingly pursue their financial self-interest. Just look around, they say, and you'll see people exhibiting all sorts of behavior that defies economic doctrine. They refuse to sell dud stocks. They assume that they can beat the market and engage in loser's strategies such as day trading. And they fail to save enough.

Richard H. Thaler, Ph.D., the University of Chicago business professor who is a pioneer in the field, has been documenting these sorts of anomalies for decades. He figured out that the average person performs poorly at saving or managing a 401(k).

His research, which RSP has drawn on, reveals that the menu of funds offered in a 401(k) plan can influence employees' investment choices, even though conventional economic theory says their goals and risk tolerance should be the determining factors. If, for example, a plan has a stock and a bond fund, many employees will plunk half of their money in each. If a plan has five different kinds of funds, they'll spread their money equally among those.

Confronted with this sort of behavior, Thaler and Shlomo Benartzi, Ph.D., of UCLA's Anderson Graduate School of Management have devised a way of channeling people's financial behavior into a force for saving. They call their plan “Save More Tomorrow” and introduced it in a scholarly paper this way: “Our goal was to design a program to help those employees who would like to save more but lack the willpower to act on this desire.”

Think of it as economic judo. Just as a judo player uses his opponent's momentum against him, their plan harnesses such behaviors as procrastination and inertia to get people to save.

Thaler and Benartzi's plan begins with automatic employee enrollment and focuses on automatic increases in contributions at every pay raise until the legal contribution limit kicks in. Although employees can quit the program at any time, many do not; inertia holds them.

RSP's leaders see great promise in Thaler's proposals, which, in effect, turn inertia and lack of awareness into forces that encourage saving. RSP wants federal agencies to clarify regulations that would facilitate the adoption of automatic enrollment and automatic contribution increases.

The project has issued other policy recommendations that would make retirement savings easier and draw not on savers' irrationality but its opposite. For instance, the Saver's Tax Credit, another practical policy that RSP endorses in its reports, is designed to encourage people to save.

The Saver's Tax Credit is available to middle- and lower-income people who contribute to an IRA or 401(k). For each dollar savers invest, they can receive 50 cents, 20 cents or 10 cents back, depending on their income. The credit helps correct what Orszag calls the “upside down” structure of tax incentives for retirement savings—that is, the tax code provides its strongest savings incentives to those who are generally better prepared for retirement.

The collaborative RSP-H&R Block experiment in St. Louis was, in one sense, a test of the effectiveness of the premise behind the Saver's Tax Credit: that moderate- and lowerincome families will save more if provided a financial incentive to do so.

The credit was signed into law by President George W. Bush in 2001, took effect in 2002 and was claimed on more than 5 million income tax returns that year. RSP senior advisor J. Mark Iwry, who previously served as benefits tax counsel in the Treasury Department, calls it “arguably the most significant legislation enacted in the last 30 years to specifically promote retirement savings for middle- and low-income workers.”

It was originally intended to be refundable, which means that people could claim it even if they had no federal income tax liability. Rather than using the credit to offset their income tax liability, as people who owe taxes would, these folks would receive it in the form of a tax refund.

But to save money, refundability was ultimately omitted, and the credit is scheduled to phase out completely after 2006. By making the credit nonrefundable, lawmakers excluded more than 50 million households. RSP's research points to the benefits of making the credit refundable and permanent and expanding it so that middle-income households have greater incentives to save.

Another RSP-favored solution is even easier: the splitting of tax refunds, which the IRS can do with a simple administrative change. And it has huge potential. The average tax refund is more than $2,000, Orszag points out, and the IRS issues a total of more than $200 billion a year in individual income-tax refunds.

“There's some empirical evidence suggesting that, given the opportunity to put part of your refund in an IRA, a substantial share of American households would do so,” he says. Because, per current IRS policy, refunds may be sent directly to only one account—usually a checking account—most taxpayers end up spending them.

Asset limits in assistance programs are another RSP target. Those who receive food stamps, Medicaid or supplemental security are not permitted self-directed retirement savings larger than $2,000 to $3,000, depending on the program. “So those who are trying to do the right thing and save for retirement are penalized,” said Orszag at the national meeting of the National Council of La Raza in Philadelphia last summer.

Although people with lots of money squirreled away shouldn't depend on government largesse, these low limits discourage people from saving much of anything. Sometimes they force folks to liquidate their retirement savings to qualify for help in times of crisis, Orszag says. That creates what he calls “an implicit tax on savings.”

“Not only that,” he told his La Raza listeners, “the rules are really complicated and confusing, even for researchers.” For instance, he notes, “Many financial planners advise clients to roll over a 401(k) into an individual retirement account when they change jobs. But if you follow this advice, you can disqualify yourself from food stamps. Doesn't make any sense,” he comments, but then adds, “We can fix this problem.”

Finally, RSP recommends financial counseling, which has been empirically shown to encourage savings and boost retirement security. In St. Louis, Denise Wilson does her part. Fortunately, she has hands-on knowledge of the contradictions and complexities of federal tax policies related to retirement. Wilson prepares tax returns at H&R Block's office on Natural Bridge Road. Many of her clients are single parents who make $20,000 to $25,000 a year.

And just as RSP's research suggests, many of them fail to save because they live from paycheck to paycheck. When tax time arrives, she says, “they need that refund to catch up on utility bills or buy clothes and shoes for their kids.”

Even so, Wilson asks her clients whether they have retirement savings. That's part of her job, but also she's trying to help: “My own commitment to doing it came with my feeling that, if you don't know any better, you can't do any better.”

Typically, her clients do not have IRAs and know little about them. If they are curious, she walks them through the rules, explaining the difference between traditional and Roth IRAs and telling them that they can pull money out for such expenses as college tuition and medical bills. Since 2002, she has also outlined the benefits of the Saver's Tax Credit. And in March and April of this past tax season, she told them about the experimental match that RSP and H&R Block had devised.

“How much do I have to put in?” was the usual first response. “Then they say, ‘Will it come out of my refund?' And I say, ‘Yes, it'll come out of your refund.'”

From the experience of setting up hundreds of these IRAs, Wilson knows that following RSP's advice and splitting tax refunds would help even more people save. The fact that H&R Block is effectively doing that is one of the things that make its IRAs attractive to her clients: They can open an IRA and still get a refund.

Wilson would also like to see the federal government expand and extend the Saver's Tax Credit to help working people save more. She has seen how even modest retirement savings can improve her clients' lives. “I had one client, a single parent, who'd been trying to save. When I first showed her how she could save in an IRA, she just broke down in tears. She's been with me for three years. Every year, she comes back, and every year she contributes a little more.”

Experience and Expertise at the Helm

RSP's common-sense approaches are bolstered by the quality of the project leadership and its advisory board. Director Peter Orszag (above) is an economist who in the 1990s worked in the White House as a special assistant to the president for economic policy and an adviser to the President's Council of Economic Advisers.

RSP's bipartisan advisory board includes former officials from the Nixon, Carter, Reagan, George H.W. Bush and Clinton administrations. The board members are: Bruce Bartlett, a columnist at The Washington Times; Michael Graetz, the Justus S. Hotchkiss Professor of Law at Yale Law School; Daniel Halperin, the Stanley S. Surrey Professor of Law at Harvard Law School; Nancy Killefer, senior director at the management-consultant firm McKinsey & Company, Inc.; Robert Rubin, director, chairman of the executive committee and member of the Office of the Chairman of Citigroup Inc.; John Shoven, the Charles R. Schwab Professor of Economics and the Wallace R. Hawley Director of the Stanford Institute for Economic Policy Research; and Eugene Steuerle, senior fellow at the Urban Institute.

Student Debt: Another Financial Squeeze

Americans are worried not only about retirement security. They are also struggling with other financial challenges, including the ability to pay for higher education. Two-thirds of all college students now graduate with loan debt, compared with fewer than half in the early 1990s. Debt per student has tripled over the last two decades, even after accounting for inflation.

Building on the RSP experience and model, the Trusts recently launched the Partnership to Reduce the Burden of Student Debt, a two-year, $3.5-million initiative to respond to this growing concern.

“The Trusts' goal,” says HHS director Maureen Byrnes, “is to advance practical, common-sense options to help ensure that paying for college doesn't put the financial future of millions of individuals and families at risk. This initiative is intended to be a resource to policy makers seeking achievable solutions to the concerns about mounting student debt.” For more information, visit

The Retirement Security Project is located at 1755 Massachusetts Avenue, Suite 550, Washington, DC 20036, and its Web site is Contact the project by phone at 202.483.1370 or via the Web at

Tim Gray writes on money and business for The New York Times and other publications. In 2001, he was a Knight-Bagehot Fellow in Economics and Business Journalism at Columbia University's Graduate School of Journalism.

Pew is no longer active in this line of work, but for more information visit the Retirement Security Project on