If plan sponsors design retirement plans, they take advantage of naive employees and exploit features of plan design that favor themselves, to the detriment of the employees trying to save for retirement.
That's according to a paper exploring the topic written by Ryan Bubb, professor of law, and Patrick Corrigan, both of the New York University School of Law, and Patrick Warren, associate professor of economics at Clemson University.
The three say that employers have the incentive to exploit mistakes made by employees in the choices those employees make to save for retirement, and as a result employers do just that.
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"[I]f workers undersave (or make other retirement savings mistakes) due to behavioral biases, then the labor market will quite generally give employers incentives to design plans to cater to and exploit, rather than resolve, those behavioral biases," the authors wrote. "Delegating choice architecture to employers results in bad choice architecture, given employers' incentives."
Some of the ways employers exploit employees' choices lies in the way employers structure retirement plans, such as low default contribution rates attached to automatic enrollment.
"One of the most celebrated findings from the behavioral literature is that employees' initial participation decisions in these plans are very sensitive to the default rule governing participation in the plan," the paper said. "If new hires have to submit the form to opt out of participation, rather than to opt in, initial participation skyrockets."
However, since "these defaults are also sticky in the opposite direction," the authors continued, "many workers who, under a traditional opt-in plan, would have enrolled at higher savings rates, will instead stick with a lower default savings rate in an opt-out design."
And that means they end up saving less overall than they would have if they had had to opt in.
That low default contribution rate can further be exploited in recruiting, when the employer matching contribution is made to appear more beneficial than it actually is.
"The employer will choose the default contribution rate that minimizes contributions to the plan," the authors wrote, "since with fewer matching contributions, the employer can then offer a higher wage."
In turn, the employees who are attracted by that higher wage "will overvalue employers' offers to match since they will overestimate how much they will in fact save for retirement."
The authors suggest that employers be banned from offering matching contributions in defined contribution plans—and they further suggested a way to fix the American retirement system. But employers—and most politicians—certainly won't like it: "Scrap the whole scheme and instead create a federally-sponsored defined contribution plan that would be supplemental to Social Security."
The use of such features means that employees are actually saving less overall than before automatic enrollment.
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