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Harvard’s David Laibson wants to tweak 401(k) plans to help soften the blow of recessions

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David Laibson, a Harvard economist known for studying why people don’t save as much as they’d like and what can be done about it, has an idea for tweaking the widely used 401(k) retirement-savings plan to help the economy better weather downturns: Allow employers to suspend their contributions during recessions and compensate by contributing more during good times.

He calls this a “Pro-Cyclical 401(k).” Under this setup, firms would contribute large amounts to their employees’ 401(k) plans during periods of strong economic growth—Laibson recommends 10% of employees’ pay—so when the economy enters a recession, these firms could temporarily halt contributions. This would reduce labor costs in the short run without firms’ having to fire employees, cut take-home pay, or decrease workers’ total retirement savings in the long run. Since a third-party would decide when a recession had started, workers wouldn’t have to fear that their employers would toggle into the no-contribution period as a cost-cutting measure in times other than general downturns.

Laibson thinks there’s a strong case to be made for why this would be helpful:

He also believes it isn’t as foreign an idea as it may sound:

This research is still in the early stages, and will have to address several concerns before it can move forward. For example, if firms aren’t required to enter this plan (Laibson thinks entrance should be voluntary), don’t they risk losing employees during recessions to companies that continue their matching programs? By investing more heavily in 401(k)s when the market is booming and not investing during market downturns, will employees routinely buy assets at their most overvalued? In the periods where some version of this idea have been used (in Singapore, for instance), what effects did it have? And as MIT Professor Antoinette Schoar observes: Do we really want business cycle risk transferred from firms to individual employees?

For more, check out Laibson’s presentation

(co-authored with John Beshears, James Choi, and Brigitte Madrian) at the Hutchins Center’s event “The Power of the nudge: Policy lessons from behavioral economics,” and see video of all his remarks here

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