Presenting financial information in an easier-to-grasp way does not affect retirement plan enrollment rates or contribution choices.
It's pretty common knowledge that financial planning for retirement is a big deal. While the average American life expectancy is 76 for men and 81 for women, many people retire at age 62. That means by the time people stop working, they need to have enough money saved up to live on for the rest of their lives, which could be 15-20 years or longer.
Despite such statistics, many people aren't making good decisions in retirement planning, said Charlene Kalenkoski, director of the Retirement Planning and Living Research Initiative in the Texas Tech University Department of Personal Financial Planning. Perhaps surprisingly, that's not because the information is too complex.
In a new study using a hypothetical employer-sponsored 401(k) plan, Kalenkosi; Eric Cardella, an assistant professor of business economics in the Jerry S. Rawls College of Business; and former Texas Tech psychological sciences faculty member Michael Parent, now an assistant professor of educational psychology at the University of Texas, examined how the presentation of financial planning information impacts retirement-savings behavior. Contrary to their expectations, they found that simplifying the information did not increase plan enrollment rates among either group studied: new employees earning more than $50,000 and business school students.
“Defined benefit plans have largely given way to defined contribution plans, putting most Americans in charge of saving for their own retirement,” Kalenkoski said. “However, many Americans are financially illiterate and are saving way too little for retirement. The goal of this research was to investigate whether simplifying retirement plan information provided by employers would encourage employees to participate in retirement plans and to make good decisions regarding how much to contribute and how to invest those contributions.
“The idea behind our study was that people starting a new job are given a lot of information and a short amount of time to make important retirement decisions. We thought that by streamlining the information and making it easier to understand, people would be more inclined to enroll. This was not the case. However, other studies have shown that having enrollment as the default and forcing people to opt out increases participation. It appears that people just don't want to take action.”
If people are increasingly responsible for their own savings, why would they choose not to enroll in a retirement plan?
“They don't want to tie up money,” Kalenkoski said. “There are some other studies that show that allowing people to borrow from their retirement plan increases participation. Also, people may not feel adequately informed about how much to contribute or in what to invest once they enroll. This gets to the issue of increasing financial literacy. Our results support financial literacy as an important factor in retirement decisions.”
In addition to participation rates, the study also addresses the more important concepts of choosing contribution rates and making investment choices.
“Even people who make the wise decision to enroll make bad choices here,” Kalenkoski said. “Some people naively invest by dividing their contribution up to invest in all choices. That is not good diversification and leads to lower returns on their investment. Some people choose the employer's default, which may be a money market fund. You don't earn enough of a return on that to end up with a decent retirement account. Some people just choose company stock, which is not diversifying at all. If the company goes under, you not only lose your job but also your retirement account. People make all sorts of bad choices because they do not know what good choices are.”
One of the mistakes Kalenkoski identified is when people don't take full advantage of employer-sponsored match programs.
“After a person has decided to enroll, they need to know what percentage of their salary they would like to contribute,” she said. “Usually they get a full match from the employer up to a certain percentage, say 4 percent – that means if they put in 4 percent, their employer will also contribute 4 percent. Some people don't take full advantage of this match. Suppose they only contribute 2 percent. Well, yes, they are not contributing an additional 2 percent themselves, but they are also not getting that additional 2 percent from their employer, so they're giving up free money.”
The next step in Kalenkoski's research will focus on default contribution rates. She particularly wants to explore how high rates must be for people to begin choosing their own rates.
“Simplifying the plan information and making recommendations about the percentage to contribute and how to invest in stocks vs. bonds did not affect people's choices in either sample. However, people were more likely to choose the defaults, consistent with other research,” she said. “So, to improve people's contribution rates and investment choices, an implication of this and other studies is to set these rates and investment choices higher than people are currently choosing. However, this is not ideal, as what is optimal should differ across individuals based on their individual situations.”