In an interview, Mr. Ellis said although Congress “went to a lot of effort to recommend” that DC plans offer automatic features, “it is time to ramp it up” and amend the Pension Protection Act of 2006. Mr. Ellis emphasized that he and his co-authors advocate that any mandate incorporate an opt-out provision.
Less than half of 401(k) plans have automatic enrollment, “and in most cases this feature is applied only to new entrants — not the entire workforce — so the impact is quite limited,” the book states. “Only about 40% of plans with auto enrollment also have automatic escalation provisions. Without automatic escalation, inertia tends to lock people who are defaulted into plans into low contribution rates.”
Mr. Ellis said in the interview the combination of a mandate and an opt-out provision acknowledges behavioral economics research and the beneficial use of inertia. Participants who are automatically enrolled in a 401(k) plan with automatic escalation with an opt-out approach are more likely to maintain their contributions than those in plans governed by an opt-in clause — meaning participants have to make an active choice to contribute.
“It's hard to stop smoking. It's hard to lose weight,” said Mr. Ellis, now a New Haven, Conn.-based investment consultant for institutions, government organizations and wealthy families. “It's hard to do things we should do.”
The authors recommend several improvements to raise participant contribution rates to an annual 12% of pay — a combination of a higher initial deferral for auto-enrollment, corporate match and auto escalation. They propose an initial deferral of 6% of pay; the most common initial deferral is 3%.
The authors also address issues that chip away at participants' retirement savings — most notably leakage from loans, hardship withdrawals and cash-outs by people changing jobs. Leakages represent at least 1.5% of 401(k) and Individual Retirement Account assets each year, “reducing aggregate retirement wealth by more than 20%,” the authors say.
“Policymakers face a dilemma in terms of preventing leakage, because studies show that employees who know that they can get access to their funds are more likely to participate and to contribute more once they join the plan,” the book states.
In the interview, Mr. Ellis said leakage remedies should be addressed by plan executives rather than by regulation or legislation. “We would like companies to tighten up on this,” he said.
Among the authors' statements on leakage:
- Plans should identify unpredictable circumstances — such as health problems, job loss and foreclosure — and allow them as acceptable reasons for participants to withdraw money from their retirement accounts.
- Participants shouldn't be allowed to borrow or withdraw money for predictable expenses - such as buying a house or paying for college - from 401(k) plans. Allowing them to withdraw retirement savings for predictable expenses “makes no sense.”
- Leakage through cash-outs “when people change jobs should be closed down entirely,” although the authors didn't offer a prescription for achieving this goal.
Although the authors recommend changes in the political and professional management of the retirement system, they say individuals must bear some responsibility, too. For example, the book says individuals should wait longer to collect Social Security benefits. Monthly benefits for those claiming benefits at age 70 are 76% higher than for those at age 62, the earliest date for claiming benefits.
Mr. Ellis said the idea for the book was based on years of reading how people make mistakes in investments. As defined benefit plans give way to defined contribution plans, “we've empowered individuals to make mistakes,” he said. “Defined benefit plans offer peace, security and comfort. The defined contribution system changes all of that.”
