A Simple Plan to Increase Retirement Saving Research by Richard H. Thaler
The Save More Tomorrow plan allows employees to allocate a portion
of their future salary increases toward retirement savings.
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
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 that money.
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 at UCLA have developed a plan called Save More Tomorrow
(SMT), 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 SMT 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 SMT plan yielded dramatic results.
The average saving rates for SMT plan participants more than
tripled, from 3.5 percent to 11.6 percent, over the course of
Turning Negatives into Positives
What makes the SMT 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 saving.
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
The SMT 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 pretty
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 SMT 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 Thaler.
The final issue hindering saving is loss aversion, the tendency
for people to weigh losses significantly more heavily than gains.
Because the SMT 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 SMT 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 workers
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
SMT 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 SMT 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 SMT 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
"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, an investment
management company, on implementing the SMT plan at U.S. divisions
of Koninklijke Philips Electronics N.V. The authors have also
held discussions with Hewitt Associates, an outsourcing and
consulting firm that focuses on human resource management.
Thaler suggests 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.
Richard H. Thaler is Robert P. Gwinn Professor of Behavioral
Science and Economics at the University of Chicago Graduate
School of Business.