Skip to main content

Verified by Psychology Today

Opt-in and Opt-out Pension Design

Does using the opt-out mechanism cause more saving?

Should contributions to defined contribution pension plans be defaulted for new employees as opt-in or op-out? They have traditionally been opt-in and this has resulted in only about one third of employees contributing.

The status quo bias causes employees to procrastinate in making their retirement plan decisions. Indeed, many procrastinate so long that they never participate in the plan. Instead of requiring the new employee to take action to enroll, enroll the employee automatically and require the person to take action to disenroll. Instead of exerting an effort to start the participation, employees participate automatically. An automatic enrollment policy in a 401(k) savings plan results in substantially more employees participating in the pension plan-a jump from one-third to nearly 90%. Although, most just stay at the default level of contribution and asset allocation. One problem with this approach is that some of the employees would have participated without the automatic enrollment. In addition, they would have contributed a higher amount and chosen a more aggressive asset allocation than the default money market fund, but they do not change the default allocation because of the status quo bias. Therefore, this automatic enrollment of employees helps many but might harm some. To overcome some of this problem, plans are now allowed to automatically enroll new employees into Life Cycle or Target Date type funds.

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


Reference: Eric J. Johnson, and Daniel Goldstein, "Do Defaults Save Lives?" Science (2003): 1338-1339, and Brigitte Madrian and Dennis Shea, "The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior," Quarterly Journal of Economics 116(2001): 1149-1187.

advertisement