The Save More Tomorrow plan allows employees to allocate
a portion of their future salary increases toward retirement
In the past decade, there has been a rapid shift among employers
from defined benefit plans to defined contribution plans.
As a result, employees now bear much more responsibility for
their retirement savings.
Under defined benefit pension plans, retirement benefits
depend on how long an employee has worked at a given company
and his or her salary by the time they retire. Firms using
these plans are essentially doing the saving for their employees.
Under defined contribution plans, which are much easier for
companies to administer, employees must take the initiative
to join. Retirement benefits depend on how much the employee
decides to contribute and how he or she chooses to invest
While defined contribution plans such as 401(k) plans offer
increased flexibility for those who enroll, studies have found
that some employees at firms that only offer defined contribution
plans contribute little or nothing to the plans.
"As we've switched over from defined benefit plans to
defined contribution plans, we've turned over responsibility
for enrollment and contribution decisions to individuals,
many of whom don't have expertise in this area," says
Richard H. Thaler, a professor at the University of Chicago
Graduate School of Business. "Now that employees have
to save for themselves, many of them just aren't doing it."
Combined with the long-standing problem of the low U.S. savings
rate, this recent shift to defined contribution plans means
that most middle-class American workers will be even less
prepared for retirement than before.
To tackle the problem of inadequate retirement saving in
defined contribution plans, Thaler and Shlomo Benartzi of
the Anderson School of Management at UCLA have developed a
plan called Save More Tomorrow (SMarT), described in their
recent paper "Save More Tomorrow: Using Behavioral Economics
to Increase Employee Saving."
"Our goal was to design a program to help those employees
who would like to save more, but lack the willpower to act
on this desire," write Thaler and Benartzi.
Using principles drawn from psychology and behavioral economics,
the plan gives workers the option of committing themselves
now to increase their savings rate later. Once employees join,
they stay in the plan until they opt out.
The SMarT plan has four basic components: First, employees
are approached about increasing their contribution rates approximately
three months before their scheduled pay increase. Second,
once they join, their contribution to the plan is increased
beginning with the first paycheck after a raise. Third, their
contribution rate continues to increase on each scheduled
raise until the contribution rate reaches a preset maximum.
Fourth, the employee can opt out of the plan at any time.
The first implementation of the SMarT plan yielded dramatic
results. The average saving rates for SMarT plan participants
more than tripled, from 3.5 percent to 11.6 percent, over
the course of 28 months.
Turning Negatives into Positives
What makes the SMarT plan work? In order to design a savings
plan that would be both effective and easy to use, Thaler
and Benartzi took into account several major roadblocks to
One reason why households aren't saving enough is the basic
problem of figuring out how much to save. According to the
life-cycle theory of saving, households decide what level
of consumption they would like over their lifetime, and then
borrow or save to attain that amount. The theory suggests
that individuals borrow when they are young, due to lower
incomes at the early stage of their careers, and then save
for retirement during their prime working years.
"Figuring out how to achieve this life-cycle savings
rate requires being able to perform fairly sophisticated bits
of economic analysis," says Thaler. "The truth is
that most of those calculations are quite hard even for an
economist to perform."
The SMarT plan helps people approximate the life-cycle savings
rate if they are unable to do so themselves.
A second issue that impedes saving is self-control. "By
inviting employees to join a few months before their raise,
the plan takes advantage of the fact that for most of us,
our self-control intentions about the future exceed our implementations
in the present," says Thaler. "For example, given
the option of going on a diet three months from now, many
people will agree. But tonight at dinner, that dessert looks
In developing the plan, the authors also addressed the issue
of procrastination, which can lead to what economists refer
to as inertia. For example, even those who actively take part
in 401(k) plans may never bother to increase their savings
rate over time or change their allocation of funds among stocks
and bonds. By making future increases automatic, the plan
eliminates the need for additional actions or self-control
on the part of the participant.
The reason why the SMarT plan works so well is that inertia
is powerful. Once people enroll in the plan, few will ever
get around to opting out. When employees reach the maximum
allocation, they keep saving at the maximum until they actively
request to change it.
"We knew people intended to save more but never got
around to it because of inertia. So we thought, let's build
inertia into the plan and make it work for us," says
The final issue hindering saving is loss aversion, the tendency
for people to weigh losses significantly more heavily than
gains. Because the SMarT plan is tied to pay increases, participants
will never see their paycheck go down, and thus there is less
perceived loss aversion.
Save More Tomorrow in Practice
The SMarT plan was first implemented in 1998 at a midsized
manufacturing company. The company suffered from low participation
rates in its defined contribution plan as well as low saving
rates. Since the company did not have a defined benefit plan,
management was concerned that some of the workers might not
be saving enough to support themselves when they retired.
The company was also constrained by U.S. Department of Labor
antidiscrimination rules that restricted the proportion of
benefits that can be paid to higher-paid employees in the
firm. Since the lower-paid employees were the ones typically
saving little or nothing, the executives were not able to
contribute the maximum normally allowed to their own plan.
With the help of an investment consultant, the company decided
the specific details of how the plan would work. Each employee
at the company was offered the opportunity to meet with the
investment consultant. Of the 315 eligible participants, all
but 29 accepted the meeting offer. Based on information from
the employee, the consultant discussed how much of an increase
in savings would be economically feasible and then used commercial
software to compute a desired saving rate. For employees reluctant
to adopt substantial increases, the consultant limited the
increase to 5 percent.
Of the 286 employees who talked to the consultant, only 79
(28 percent) were willing to accept his advice. For the rest
of the participants, the consultant offered a version of the
SMarT plan, proposing that they increase their saving rates
by 3 percent per year starting with the next pay increase.
This was quite aggressive advice since pay increases were
barely more than this amount. The pay increases were scheduled
to occur roughly three months later. With the 3 percent a
year increases, employees would typically reach the maximum
tax deferred contribution within four years.
The plan proved to be extremely popular with the participants.
Of the 207 participants unwilling to accept the 5 percent
saving rate, 162 employees (78 percent) agreed to join the
SMarT plan. Virtually everyone (98 percent) remained in the
plan through two pay raises, and 80 percent of the participants
remained in the plan through three pay raises. Furthermore,
even those who withdrew from the plan after the second or
third pay raise did not reduce their contribution rates to
the original levels, they merely stopped future increases
from taking place. So even those workers were saving significantly
more than they were before joining the plan.
Several subsequent implementations of the SMarT plan have
taken place since the study was first conducted. While the
first company was willing to spend the money to hire a consultant,
subsequent implementations have had to be less expensive.
In these cases, employees were introduced to the plan via
letters, posters in cafeterias, and the occasional special
lottery to give them incentives to join. Most of these recent
implementations have used a 2 percent increase, so as long
as the employee's raise is more than 2 percent, they will
still have extra money for themselves.
"The plan is most effective with in-person enrollment,
when there is a person who can help the employee fill out
the form and take it out of their hands," says Thaler.
"If the employee has to return a form in the mail, participation
rates fall off."
Interest in the plan has been growing rapidly. Thaler and
Benartzi are currently working with the Vanguard Group, who
have offered the plan to all the companies whose 401(k) plans
they administer. Several other large plan administrators are
also pilot testing the idea.
Thaler hopes that the plan may one day become standard operating
procedure in most 401(k) plans. "We're giving this idea
away for free. All we ask for is the data," says Thaler.