It’s true for everyone: despite our best intentions, we often fail to accomplish what we set out to do. When it comes to retirement investing, millions of Americans do not meet their own declared saving goals for retirement.
As a result, almost one-third of the U.S. population has no retirement savings at all, while many others will fall well short of what they will need for their Golden Years.
A solution can be found in the field of behavioral economics, which suggests ways to help Americans start saving. It seems that saving is a lot like dieting — small changes can help you reach your goal.
For example, many studies have shown that being automatically placed in a savings plan dramatically boosts participation by employees — even if they can opt out.
These studies show that when an automatic savings plan is introduced with an opt-out, 60% to 70% of employees remain in the plan. This may seem like a technical nuance, but there is a big difference between opting in by completing an application versus choosing not to opt out.
A plan designed to take advantage of this behavior is called an automatic IRA. In the same way that many people fail to start saving, those placed in an automatic IRA simply fail to stop saving by withdrawing from the plan. Automatic IRAs help people build their savings using the power of inertia.
Here’s how: Workers in firms above a certain size without company-sponsored retirement plans are required to contribute to an IRA plan — unless they chose to opt out. These plans are relatively easy to administer for employers who simply “connect” their employees to a retirement plan run by a qualified financial institutions. The plans save small businesses from the hefty paperwork and sometime onerous regulations associated with traditional retirement plans.
Around 60 million U.S. workers currently do not have a retirement plan offered by their employers and many of these people work in firms with fewer than 100 employees. Automatic IRAs are particularly valuable to these people. Nevertheless, while Congress has considered the automatic IRA for years, it has not come close to passing this legislation.
The federal government should make this kind of plan available nationwide — creating uniform standards and solid investment outcomes for all plan participants. But given the current political vacuum, several states have taken the lead, adopting their own versions of an automatic IRA. These states include California, Illinois, and Oregon — each with a modestly different approach.
Accordingly, it’s up to the federal government to minimize conflicts among state IRA plans as they proliferate, and make sure that the retirement savings of workers are invested well. While the Department of Labor (DOL) has proposed some rules for state-run automatic IRAs, these rules when adopted should have tougher restrictions — specifically:
1. The DOL should push for uniform rules so there won’t be conflicts for employers. Perhaps states could agree on a standard template for all state IRA plans —- like the uniform state codes promulgated on other subjects.
2. States should be limited to collecting employee contributions and hiring independent asset managers to invest in diversified pools of liquid securities. States should not be responsible for the actual investments.
3. State employees and the asset managers they hire should be subject to the same fiduciary standards mandated by ERISA — the federal pension law. They should be required to act as prudent experts and avoid conflicts of interest.
4. The DOL must require full disclosure by states of the risks of these plans. States should not offer any guaranteed returns.
Automatic IRAs are a small piece of what America should do to forestall a major crisis as waves of baby boomers retire. Automatic IRAs will be even more powerful if sponsored and administered by the federal government, but for now state plans with strong protections may be the most feasible way forward. Sometimes the best way to attack a big problem is with a simple first step.
Editor’s note: This piece originally appeared in MarketWatch.