This paper considers over 500 different 401k plans and examines how different aspects of plan design make the plan an attractive investment and influence the participation rate in the plan. More specifically the authors examine how changes in features such as the structure of the employer match, the presence of loans, and the investment menu design affect savings behavior by workers. From a sample of 740,000 workers, the authors find that in the average 401k plan only 10% of non-highly-compensated workers were influenced to save more due to increased match incentives. 30% failed to join the plan at all, despite the fact that their real return premium would be anywhere from 1-5% above market rates. The remaining workers were found to participate in the savings plan regardless of the employer’s matching of funds.
To participate in a 401k savings plan an employee must first contribute part of his salary, then the employer usually matches the amount invested, up to a certain percentage of the employee’s income, as an incentive for its employees to save. Another aspect of a 401k plan that make it an attractive way to save for retirement is that the savings are tax-free until withdrawal. Some features that could potentially hinder employee participation include:
The authors develop two models for their analysis. The first attempts to link employees saving patterns with changes in the factors listed above, and also controlling for employee investment patterns independent of plan design, plan size, industry of the offering company, and presence of other plans. This will show the magnitude of impact on savings attributable to either features of the 401k plan itself, employee saving characteristics, or features of the sponsoring firm.
The second model examines the actual employer’s matching contributions to their 401k savings plans, compared to the amount that the company actually promises to match dependent upon employee participation. Companies’ matching expenditure will increase as more employees participate in the plan. This model examines how the actual amount of savings matched or program participation varies as a result of changes in plan features, worker characteristics, and employer-side variables.
Data on the 500 401k plans is obtained from Vanguard, for the 2001 plan year. This data includes information on plan match formulas, features of the plan’s investment menu, the presence of other retirement plans, and indicators of participant access to plan accumulations prior to retirement. Information was also gathered on about 740,000 employees from firms offering such plans. Information on the workers included workers’ age, sex, job tenure, annual salary, plan participation, plan contribution amounts, and asset and contribution allocation information. The average size firm in the sample was mid-sized with about 1500 employees, and 82% offered a matching contribution for employee 401k plan contributions. The most common match was the single-tier match formula where approximately 50 cents per dollar on the first 6% of the amount saved by the employee. There were also multi-tier formulas where a higher percentage would be matched on the first 2% of salary saved and less on subsequent savings. Overall about one-third of all the plans promised to match less than 3% of pay; about one-third offered a match of up to exactly 3% of pay; and the other third offered over 3% of pay.
The average employee in the sample is a 43-year-old male earning about $63,900 a year, and has spent almost nine years on the job. The average plan participation rate from the sample was about 77% with an average savings rate of about 6.8% of total salary. An important finding was that the typical employer promised a matching of about 3%, but the average actual matching expense was only about two thirds of that at 1.9% of pay. In other words many workers were forfeiting potential earnings because they fail to save at a rate that maximizes return or they fail to participate at all.
Results suggest that changes in matching incentives had only a small effect in changing this participation rate. The authors also conclude that workers effectively forfeit about half of their promised retirement compensation because they fail to maximize the match being offered by their employers. They also find that the liquidity of these plans and investment constraints also only contributed a small amount to the participation rate of these plans.
The study drew from a large sample and was sufficient to support the authors’ conclusion. This study helped confirm the fact that people often make unwise investment choices. The amount of potential earnings that employees give up by not participating in the savings match program was surprising. It seems to me that if a company wants to help increase savings participation they should just make it company policy, to enroll in a plan. Mandatory savings systems have been implemented in other countries, such as Australia and Singapore. Further research should be conducted comparing the return on saving systems in Australia and Singapore with those in the United States. This would be an extensive, but nonetheless very relevant to the topic studied in this paper.
The authors should consider the wealth of investors. Low-income earners can’t afford to save as much because they have to eat today. $100 in 50 years won’t matter if they die tomorrow from starvation. The authors should examine the extent to which individual wealth influences savings. They should also examine if there are any saving trends for different income ranges or different industries. I think those would have added greatly to this paper that currently muddles most people together. People don’t save for a lot of reasons, not just because of stupidity.
Also, did employees who don’t invest take their money elsewhere? Some people invest their money themselves, and 401ks are not the only savings tool. If the authors examine what employees who don’t invest in 401ks do with their money, the authors may be surprised to find that those employees simply invest their money elsewhere, and maybe even earn higher returns.