Will You Save More Tomorrow?

The SMarT program uses psychology to help employees save.

Posted Sep 01, 2009

If you plan to live a life of comfort in retirement, most of your retirement income will need to come from your savings. Social Security won't provide much and defined benefit retirement plans are becoming extinct. So how do we get people to contribute to their own defined contribution plan (i.e., 401k plan)?

Richard Thaler and Shlomo Benartzi proposed a four-step approach that they call Save More Tomorrow (SMarT) that overcomes several psychological biases. They suggest that employees who are not contributing to their 401(k) plan can begin to do so by agreeing to the following plan:

(1) The employee is asked to agree to the plan well in advance; that is, the decision does not have any immediate ramifications.
(2) The plan starts by having the employee agree to begin contributing at his/her next pay raise with a small contribution rate, such as 2 percent. By combining a pay raise with the contribution, the employee still sees a small increase in pay but also begins the contribution.
(3) The employee agrees to increase the contribution rate at each pay raise until a preset maximum level is reached.
(4) The employee can opt out of the plan at any time. Although the hope is that employees will not opt out, the ability to do so makes them more comfortable about joining the plan.
(5) The SMarT plan requires the employees to make decisions far in advance, and then the status quo bias works to their advantage because they do not take the option of opting out of the plan.

This plan was tested at a midsize manufacturing company whose savings participation rate was low. The 315 employees had an average savings rate of 4.4% of their earnings. They were asked to increase their contribution by 5%. Those employees who claimed they could not contribute the 5% were offered the SMarT program. The program was made available to 207 employees, and 162 employees agreed to join. These employees had a low savings rate of 3.5%, on average. The 153 employees who did not join the SMarT plan either did nothing or made a one-time increase in their savings rate. On average, the people who did not adopt the SMarT plan had a savings rate of 5.3%. The effect of joining the plan was dramatic. After three pay raises, those who had joined the SMarT plan had increased their savings rate from 3.5 to 11.6%. Those who did not join the SMarT plan increased their savings rate from 5.3% to only 7.5%. The dramatic increase in the savings rate associated with the SMarT plan was beneficial to those employees because they began saving more for their retirement.

For other programs that use psychology to help people make better decisions, see my post.

Reference: Richard Thaler and Shlomo Benartzi, "Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings," Journal of Political Economy 112(2004): S164-S187.