Getting More From Retirement Savings Programs

1
Getting More From Retirement Savings Programs

• Alexander Gelber
• Harvard University and NBER
• May 19, 2009

2
Overview

• Why encourage retirement savings?
• Some people splurge even though they would like
  to save
• Need to target incentives to those who are
  under-saving
• Implications for policy

3
Why Encourage Retirement Savings?

• One efficiency rationale People can be impulsive
  or myopic in their saving decisions
• You splurge today
• Your better self wants to save for tomorrow
• Illiquid savings
• Commits people to follow their long-run interest
• Improves economic well-being
• Same people will under-invest in learning about
  financial programs

4
Healing the Healthy

• Those who under-save are least likely to
  understand financial instruments and respond to
  high rate of return of special savings programs
• DC IRAs, 401(k)s
• IRAs and 401(k)s poorly targeted
• Disproportionately subsidize saving of those who
  would save adequately in absence of savings
  programs
• Disproportionately subsidize saving of those most
  likely to substitute tax-favored savings for
  other savings (Engen and Gale 2000)

5
Better Targeting Healing the Ill

• Target incentives to save toward those who
  splurge
• Incentives to contribute to special savings
  account should be front-loaded
• Targets those who consume today instead of save
• Increasing the salience of incentives could
  increase response especially among financially
  unsophisticated
• Tax incentives could be mailed as a refund
• Simplification would help target to those
  under-saving, who are likely to be confused by
  complexity

6
Defaults Effective and Well-Targeted

• Defaults very effective in stimulating saving
• More than double 401(k) participation (Madrian
  and Shea 2001)
• Increasing effective rate of return produces
  modest increase in participation (Beshears, Choi,
  Laibson, and Madrian 2007 Duflo, Gale, Liebman,
  Orszag, and Saez 2006)
• Defaults can be much less expensive per extra
  dollar saved

7
Defaults Effective and Well-Targeted

• Typically agreement in empirical literature that
  relative to their optimal saving, the poor
  under-save more often than the rich
• Defaults raise saving more for low-income
  individuals
• More generally, defaults likely to increase
  saving of financially unsophisticated people who
  are more likely to be under-saving

8
Defaults Effective and Well-Targeted

• Role of defaults should be increased relative to
  matches
• Both better targeted and more bang for the buck
• Regardless of whether Americans are usually
  under- or over-saving
• Ability to opt out accommodates heterogeneity
  better than a mandate
• Auto-IRA

9
Better Targeting

• Financial incentive from government usually a
  deduction
• Gives biggest savings incentives to upper-income
  individuals inefficient targeting
• Obama budget makes Savers Credit refundable
  targets the right group
• Remaining question will people be sufficiently
  responsive to match to justify revenue loss?
• Financial education may be well-targeted

10
Conclusion

• Subsidies for illiquid saving can improve
  economic welfare if people have self-control
  problems or lack financial sophistication
• Government intervention should be oriented toward
  those who are under-saving
• Suggests several policies
• Soon, salient, and simple relatively effective
  for those who have difficulty saving
• Role of defaults could be increased relative to
  matches