Life by default

Present bias and inertia lead to low enrollment in 401(k) retirement plans even though employer matching of employee contribution is quite generous.

Most employers match fully or partially employee contribution to their 401(k) retirement plans. A full match means that a $100 employee contribution will be doubled to $200 right away. This yield is much higher than any regular savings bank account. But surprisingly, only 49% of eligible employees make any matchable contribution. Those who do not are literally throwing money away.

This low enrollment rate turns out to hinge on the default position of most 401(k) plans. Namely, employees have to opt in to the plan when they are first employed. And opting in means going through thick literature and choosing among a long list of investible mutual funds. The immediate time cost and hassle factor have thus delayed the decision beyond the enrollment deadline. So not opting in means opting out.

It is amazing how many current "choices" in life represent not outcomes resulting from deliberate decisions, but only default positions that did not require any more effort than simply not acting to change the defaults. When faced with immediate costs and future benefits, people systematically exaggerate the near costs and undervalue the distant benefits.

In view of this present-bias effect, it may be easier to change behavior by simply resetting the default positions. Sure enough, when participation in 401(k) was set as the default position in one American firm, enrollment went up from 49% to 86% for newly eligible employees (Economist). Presumably, the decision to opt out was too "burdensome" to carry out.

That people are too lazy to change default positions even though alternative positions may be more optimal flies in the face of the bedrock assumption of rational economic agents who are supposedly constantly trying to squeeze out inefficiency. Maybe this bedrock assumption of rationality is also a default assumption that merely reflects the tendency of economists to avoid unpleasant immediate cost of re-modeling human behavior.

  • Economist. 8/27/2005. "Pensions by default."
  • Jiang, W. et al. "How Much Choice Is Too Much?: Contributions to 401(k) Retirement Plans," chapter in Pension Design and Structure: New Lessons from Behavioral Finance, edited by Olivia Mitchell and Stephen Utkus, Oxford University Press, 2004, pp 83-96.
  • O'Donoghue, T. & M. Rabin. "Doing It Now or Later," American Economic Review, March 1999.
  • Thaler, R.H. and S.Benartzi. "Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving." 2001. Working paper.


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