The determinants of individual saving and investment outcomes.

• Author: Madrian, Brigitte C.

Over the past 30 years, employer provided defined contribution (DC) savings plan largely have displaced traditional defined benefit (DB) pensions in the private sector. In 1975, there were 2.4 active defined benefit plan participants for each participant in a private sector defined contribution savings plan. By 2007, these proportions had almost reversed, with 3.4 active defined contribution savings plan participants for each defined benefit plan participant. As this shift puts more and more individuals in the position of having to self-manage the process of saving for retirement, a natural question is just how well are individuals doing, and what factors affect their retirement saving outcomes. My research over the past several years has tried to address these broad questions.

Institutional Features and Savings Outcomes

Much of my recent research evaluates the effects of different institutional features on individual savings and investing outcomes. One example of such a feature is the default--that is, what happens if an individual does nothing? As an example, in a typical employer-sponsored savings plan, individually are only enrolled if they actively elect to join the plan: the default is non-participation. Some companies, however, have a different default--they automatically enroll employees in their savings plan unless employees actively opt-out.

My research with several different collaborators, most notably David Laibson, James Choi, Andrew Metrick, and John Beshears, shows that changes in the nature of savings plan defaults have a tremendous impact on realized outcomes. We examine savings plan participation rates for employees hired before and after several firms instituted automatic enrollment and find that participation is substantially higher under automatic enrollment. (1) One concern with automatic enrollment is that it may "coerce" employees into savings plan participation. If so, we would expect that many participants under automatic enrollment should eventually opt out of the savings plan. But we observe very low attrition rates under either an opt-in or an opt-out participation regime. High participation rates and low attrition rates under automatic enrollment suggest that most employees do not object to saving for retirement. In the absence of automatic enrollment, however, many simply delay joining their savings plan.

Interestingly, the impact of automatic enrollment on savings plan participation is not very dependent on the existence or generosity of an employer match) This finding is significant because many extensions of automatic enrollment (for example, the recently adopted KiwiSaver program in New Zealand, or the Automatic IRA proposals in the United States) do not require an employer match but nonetheless allow individuals to opt out.

Automatic enrollment also affects savings plan contribution rates and asset allocations. In an opt-in regime, employees must choose a contribution rate and asset allocation when they enroll. Under automatic enrollment, the company specifies a default contribution rate and asset allocation for employees who don't actively choose otherwise. In companies without automatic enrollment, the modal contribution rate tends to be the match threshold (the contribution rate at which employees receive the full employer match). In contrast, the modal contribution rate of participants hired under automatic enrollment is the automatic enrollment default chosen by the company (initial defaults of 2 percent or 3 percent of pay, usually below the match threshold, are typical). This shift in the modal contribution rate is driven not only by the increased participation generated by automatic enrollment (which moves people from zero to a positive contribution rate), but also by individuals who would have otherwise contributed at a higher rate but who instead remain at the automatic enrollment default.

Similar patterns hold with respect to asset allocation. A large fraction of savings plan participants stick with the employer-chosen default asset allocation under automatic enrollment, even when the default is an allocation that very few savings plan participants actively elected prior to automatic enrollment. Asset allocation defaults also matter outside the context of automatic enrollment; in companies that direct matching contributions to employer stock, very few employees actively change their allocation ex post, even when they have the ability to do so. (3)

Why do defaults have such a persistent effect on outcomes? One explanation is that the default is perceived as an endorsement of a particular outcome. There is some evidence consistent with this...