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 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

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