But Where Does the Money Come From?
Nudging people to increase retirement contributions may seem beneficial, but it is important to assess whether it leads to new savings or merely shifts money from other accounts or increases debt. Studies from Denmark and the military suggest nudging produces mostly new savings without significant debt increase.
THE IDEA
But Where Does the Money Come From?
An important question to ask is whether nudging people to increase their contributions to a retirement savings account produces an actual increase in net savings or just shifts money around from other (taxable) accounts or, worse, makes people incur debt (by, for example, taking out more loans).
The first worry is quite legitimate, but it has little to do with nudging per se. Compare two hypothetical government policies:
- Require firms to adopt automatic enrollment.
- Increase the limit on how much people can contribute to their retirement account.
We can be confident that the contributions to retirement savings that are induced by the automatic enrollment policy are almost entirely new savings, because those who are nudged to join were, as a group, doing almost no saving elsewhere. The workers who do not opt in to a 401(k) plan are predominantly lower-paid employees without a college degree. In contrast, increasing the savings limit will produce very little new savings because only a small percentage of workers are at the maximum, and those who are maxed out did not need any nudges to get them there. If they weren’t figuring that out for themselves, their financial advisers would have helped them!
But if nudging people to join the plan or increase their savings rate is mostly influencing the bottom half of the income distribution, we should be concerned whether those encouraged to enroll or save more will end up having more debt sometime down the road. After all, the money has to come from somewhere. It has long been hard to assess this issue because researchers do not have access to the financial records of the participants in the plan. However, two cited studies have overcome this problem, and provide reassuring results.
The first study took place in Denmark and was possible because the Danes keep meticulous records on household wealth as well as income.10 The research team examined what happened when workers switched jobs, say, to a company with a more generous retirement savings plan. They concluded that these plan features produced almost entirely new savings with no noticeable increase in debt. A second study evaluated the effect of introducing automatic enrollment in 2010 to a group of civilian employees of the military.11 They found that after four years there was no significant change in credit scores or debt balances. They did find some statistically weak evidence of increases in mortgage debt, but we do not find that worrying. If Joe and Harry are identical in every way except that Harry has taken out a mortgage to buy a home, who would you guess is better off financially? We would bet on Harry, except perhaps in the years just before the financial crisis, when many people were induced to take on ill-advised mortgages.
When to use it
Policy makers considering implementing automatic enrollment in retirement plans can use this framework to assess net savings impact.
Employers designing retirement benefits can evaluate whether nudging leads to increased overall savings.
Financial advisors can advise clients on the effectiveness of automatic savings features.
Researchers studying behavioral interventions can apply this question to ensure they measure true net effects.
FROM THEORY TO EVERYDAY LIFE
In practice
Hypothetical Government Policies
Two policies are compared: (1) Requiring firms to adopt automatic enrollment, which nudges lower-paid, less educated workers to save, producing mostly new savings. (2) Increasing contribution limits, which primarily benefits high-income workers already maxing out, producing little new savings.
Danish Study on Job Switchers
Researchers in Denmark found that when workers switched to employers with more generous retirement plans, the increased retirement savings came almost entirely from new savings, with no associated rise in debt.
A MOMENT TO REFLECT
Put it to work.
When evaluating a nudge policy, what data would you need to determine if it increases net savings?
How might nudging affect different income groups differently?
What are the potential downsides of nudging if not properly evaluated?
CONTINUE THE CONVERSATION
Source texts
- Nudge The Final Edition (Richard H. Thaler Cass R. Sunstein)