Getting More From Retirement Savings Programs Alexander Gelber Harvard University and NBER May 19, 2009

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

Why Encourage Retirement Savings? One efficiency rationale: People can be impulsive or myopic in their saving decisions 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 Commits people to follow their long-run interest Improves economic well-being Improves economic well-being Same people will under-invest in learning about financial programs Same people will under-invest in learning about financial programs

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 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 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)

Better Targeting: Healing the Ill Target incentives to save toward those who splurge Target incentives to save toward those who splurge Incentives to contribute to special savings account should be front-loaded 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 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

Defaults Effective and Well- Targeted Defaults very effective in stimulating saving 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

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 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 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 More generally, defaults likely to increase saving of financially unsophisticated people who are more likely to be under-saving

Defaults Effective and Well- Targeted Role of defaults should be increased relative to matches 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 Ability to opt out accommodates heterogeneity better than a mandate Auto-IRA Auto-IRA

Better Targeting Financial incentive from government usually a deduction Financial incentive from government usually a deduction –Gives biggest savings incentives to upper-income individuals: inefficient targeting –Obama budget makes Saver’s 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 Financial education may be well-targeted

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