“An object at rest or in uniform motion will remain in that state unless an external force acts upon it.”
Newton’s First Law of Motion, 1687, translated from Latin
Isaac Newton was experimenting with inanimate objects when he discovered the laws of motion. But we in the retirement industry know only too well that these laws also apply to human nature. In an age when it is up to employees to take action in order to build retirement security, inertia has been a major impediment.
Fortunately, the leading behavioral economists of our time are showing us how to harness the power of inertia to work for retirement savers instead of against them.
I believe one of the most important challenges facing the retirement industry over the next decade is how vigorously we apply those lessons to defined contribution retirement plans like 401(k)s.
It’s been clear for some time — but it is now undeniable — that in the United States defined contribution plans are the primary source of employer-based retirement income. Defined benefit plans, where the employer takes the action and makes the decisions, still play a role but they will continue to decline.
For the vast majority, this is an era of personal responsibility.
This trend will occur in most other countries in the world as well. So we must challenge ourselves to help defined contribution plans maximize retirement security for all workers. If we don’t, it will be a broken promise for many.
For years, the industry focused primarily on education, hoping to convince employees of the need to save. While defined contribution plans have helped millions of Americans amass trillions of dollars, we know more needs to be done. More Americans need to participate in worksite plans and those who do need to save at higher levels. We also know that some have made poor investment choices and never made changes, thanks to inertia.
We now know better.
Our work with behavioral economists and our own research have shown how to design retirement plans that make employee inertia work for good outcomes instead of causing poor outcomes.
- Auto enrollment at a 6 percent rate or higher
- Automatic step-ups of 1 percent a year to least 10 percent of pay
- Sweep all existing employees into the plan at least one time at the higher default rate
- Stretch the employer match using a formula that incents employees to save at higher levels
- Use of asset allocation choices for the default investment alternative
Our analysis has found that key design features do move the needle on participation and savings.
But change is not easy. Conversations still tend to revolve around fund selection or fees. Granted these are important topics but the most important final determinant of retirement savings success comes down to the actual savings rate. If we don’t get people into plans, saving at higher levels, using well-diversified investments, they won’t have enough income to live on in retirement.
I’ve challenged The Principal and I am challenging the industry— providers, financial professionals, plan sponsors — to be visible, vocal evangelists for plan designs that produce healthier outcomes. There are powerful benefits for employers who make these changes. Our retirement system is strong. But we can make it even stronger.
Newton’s third law says that for every action there is an equal and opposite reaction. We know the actions to take that can spark the reactions that lead to better savings behavior. It’s up to each of us to be active advocates for plans that work.