Decades of psychological research have revealed a fundamental reality about our human nature: we are lazy when it comes to planning for long-term issues like retirement. The silver lining is that studies have also found that the government and private sector can actually translate our laziness into smart retirement decisions with low-cost interventions. In the aggregate, this could be one solution that addresses America’s looming retirement crisis.
We call it looming, but the retirement crisis has already arrived. 10,000 Baby Boomers will retire every single day of 2017 in the United States. If the Social Security Administration’s estimates are correct, Baby Boomers—a generation of almost 80 million Americans—will retire at this same rate for at least the next 15 years.
But as Americans approach retirement, they are woefully underprepared. The median household nearing retirement has saved only $14,500. But this number is deceptive, it obscures the fact that almost half, or around 40 million working age households, do not have any personal retirement savings.
This problem will worsen over the next several decades because fewer and fewer private companies are offering pensions. Among Fortune 500 Companies, the number of employees covered by pension plans fell from 60 to 24 percent between 1998 and 2013. Public pensions for state employees like teachers, firefighters, and policemen, aren’t faring much better, with states facing a $1 trillion shortfall in pension funding.
To top it all off, the Social Security Trust Funds are dwindling as more workers retire and fewer pay into the system. Over the next decade, the nonpartisan Congressional Budget Office (CBO) projects that outlays for Social Security, already the U.S.’s single largest government program, will nearly double from $910 billion in 2016 to $1.7 trillion by 2027. Absent any reforms, CBO predicts that Social Security would need to cut payments by almost a third in 2030 to remain solvent, around the time that the final wave of Boomers retires.
So what can policymakers do to tackle this problem? While policy options to shore up Social Security and provide tax incentives to companies providing pensions seem like a nonstarter in today’s political climate, changing personal behavior and biases lie at the heart of a long-term solution.
Studies in behavioral economics and nudging show several ways to spur additional saving. Nudges, according to Harvard University’s Cass Sunstein, are “liberty-preserving approaches that steer people in particular directions, but that also allow them to go their own way.”
So how can the government nudge citizens into saving for retirement? Three ways:
First, automatic enrollment in retirement plans has a proven track record of promoting and increasing savings. Put simply, the default option matters. Automatic enrollments are a powerful tool because they help people overcome cognitive biases (i.e. our own laziness), such as inaction and procrastination, and also use the power of suggestion to make saving the norm.
We know from case studies that for this plan to work, the default contribution must be high enough at the onset or increase gradually over time to add up to enough savings. That’s because our laziness strikes again, and most employees will never alter the original contribution amount.
But if structured properly, there appears to be significant potential to incentivize greater saving through automatic enrollments. One study found that automatic enrollment in a company’s 401(k) resulted in 86 percent participation rates, compared with just 37 percent when employees were required to opt-in to the plan. Achieving a 50-percentage point jump is a remarkable feat for such a simple tweak in policy. If all workplaces implemented a change in the default, we could see millions more households saving for retirement.
Second, government and the private sector can promote life cycle defined contribution plans—investment portfolios tied to a person’s retirement date. In light of the fact that only 1 to 3 percent of investors change their initial portfolio investments, using life-cycle funds that automatically rebalance each year is one approach to overcome the cognitive biases that could result in less saving over time. Pegging savings to a participant’s retirement date allows for increased returns early on, and more effective risk management for participants as they approach retirement.
Third, the government needs to assess whether its existing attempts to spur additional retirement savings are working as intended. Right now, tax deductions for retirement contributions don’t seem to be working as intended. One study found that the effect of retirement tax incentives was negligible in increasing saving—for every $1 of the government spent through the tax code, citizens’ additional retirement contributions increased by a paltry one cent.
In addition to reality-testing existing programs, there needs to be an emphasis on equity by targeting underserved workers or the Boomer population without savings. A relatively new U.S. Treasury-led program called myRA has partnered with employers to assist workers who lack access to a workplace retirement savings plan or cannot afford minimum dollar thresholds for individual retirement accounts. This type of public-private innovation is necessary. Regardless of whether programs like myRA are a success or a failure, the government and employers can learn from these pilots before adopting more comprehensive policies to help prepare Americans of all income brackets.
Behavioral nudges are by no means the silver bullet to spur savings, but they represent a crucial step in long-term wealth generation for retirees. Nudges provide a relatively low-cost solution that could significantly alter existing habits and overcome our overwhelming laziness when it comes to saving money. And if the new habits stick, even micro changes in the present can yield macro effects over time. If successful, retirement can remain the golden years instead of the lean ones.
This piece was originally published on PolicyShop, a blog of the Behavioral Science & Policy Association.