Over the past quarter century, private pension plans in the United States have trended toward a do-it-yourself approach, in which covered workers bear more investment risk and make more of their own decisions about their retirement savings. Some workers have thrived under this more individualized approach, amassing sizable balances in 401(k)s and similar plans, which will assure them a comfortable and relatively secure retirement income.
For others, however, the 401(k) revolution has fallen short of its potential. Work, family, and other more immediate demands often distract workers from the need to save and invest for the future. Those who do take the time to consider their choices find the decisions quite complex: individual financial planning is seldom a simple task. For many workers, the result is poor decision making at each stage of the retirement savings process, putting both the level and the security of their retirement income at risk. Even worse, in the face of such difficult choices, many people simply procrastinate and thereby avoid dealing with the issues altogether, which dramatically raises the likelihood that they will not save enough for retirement.
A disarmingly simple concept—what we call the automatic 401(k)”—has thepotential to cut through this Gordian knot and improve retirement security for millions of workers through a set of common sense reforms. In a nutshell, the automatic 401(k) consists of changing the default option at each phase of the 401(k) savings cycle to make sound saving and investment decisions the norm, even when the worker never gets around to making a choice in the first place. Given the current structure of most 401(k) plans, workers do not participate unless they actively choose to. In contrast, under an automatic 401(k) they wouldparticipate unless they actively choosenotto—and similarly for each major decision thereafter. Contributions would be made, increased gradually over time, invested prudently, and preserved for retirement, all without putting the onus on workers to take the initiative for any of these steps. At the same time, however, workers would remain free to override the default options—to choose whether or not to save, and to control how their savings are invested—but those who fail to exercise the initiative would not be left behind.
The steps involved in building an automatic 401(k) are not complicated, and the benefits could be substantial; indeed, a growing body of empirical evidence suggests that the automatic 401(k) may be the most promising approach to bolstering retirement security for millions of American families. A number of economists have undertaken important research and contributed practical suggestions concerning the actual and potential uses of automatic enrollment and related default arrangements in 401(k) plans. Drawing on their contributions, this policy brief describes the motivation for, the features of, and the potential benefits of the automatic 401(k).
Pew is no longer active in this line of work, but for more information visit the Retirement Security Project on PewHealth.org.