States embrace nudge theory to promote retirement savings

A new government program that takes money out of people’s paychecks is gaining interest in state legislatures across the country — in part because it is wildly popular with voters.

Oregon, Illinois and California have launched initiatives to create retirement savings accounts for residents whose employers do not offer company-sponsored programs. In those states, tens of thousands of workers have saved more than $40 million for their own retirements.

The programs automatically divert 5 percent of an employee’s paycheck into a retirement account with a few basic investing options. Employees have the option to set a different savings level, or to opt out entirely, without penalties.

The new programs are meant to address a growing percentage of Americans who are not prepared for retirement.

About a third of households headed by those over the age of 55 have no savings, according to Federal Reserve data.

Another Fed study found 61 percent of Americans would be able to cover a $400 emergency expense with cash, but the other 39 percent would be forced to borrow money from relatives or carry a balance on a credit card to meet that expense.

“About half the people who are working in the country and in Oregon too don’t have any way to save for retirement. They’re totally on their own,” said Tobias Read (D), the Oregon state treasurer who runs his state’s program, OregonSaves. “How do we put the power of compound interest to work for people?”

To spur more savings, the new programs rely on behavioral science research pioneered by Richard Thaler, the Nobel Prize–winning University of Chicago economist, and Cass Sunstein, a University of Chicago legal scholar, whose work led to an approach to public policy known as the nudge theory.

That theory relies on subtle social cues meant to influence behavior.

Two other economists, David John — then at the conservative Heritage Foundation — and Mark Iwry at the progressive Brookings Institution, applied that theory to propose an automatic individual retirement account, a plan both then-Sens. Barack Obama (D-Ill.) and John McCain (R-Ariz.) endorsed in 2008 while they were running for president.

The nudge comes in the default setting: Workers are much more likely to begin and continue saving if they are automatically opted into the program, rather than if they have to take affirmative steps to join.

“States that have taken a leadership role in setting up these retirement savings programs understanding that most people haven’t saved very much,” said Angela Antonelli, who runs the Center for Retirement Initiatives at Georgetown University.

Workers “have been hungering for this kind of opportunity, for someone to make it just that much easier for them, given everything else they have going on in their lives, to save for retirement,” she added.

Some financial services firms opposed the initial legislation in the three pilot states. Those groups argued that the government was getting too involved in what should be handled by private business.

Asked about the government-run opt-out programs, a spokesman for Fidelity said the company favored a different approach.

“Fidelity appreciates policymakers’ interest in improving retirement coverage and increasing retirement savings,” said Eric Sandwen, a Fidelity spokesman. “We believe the best approach to address the retirement coverage gap is to make enhancements to the existing private retirement system.”

Sandwen urged Congress to pass legislation sponsored by House Ways and Means Committee Chairman Richard Neal (D-Mass.) that would expand multiple employer plans. That bill passed the House with 417 votes; it has stalled in the Senate.

But Read said opposition in Oregon was fading as financial services companies begin to see those new savers as potential customers down the road.

“To try to serve a high number of low-balance accounts is not profitable. So that is something government should be doing, in my opinion, getting people started,” he said. “In the long run, we’re growing their future customers. What we have in our program is super basic, and if we succeed, it’ll be great and people will have enough in their accounts to become dissatisfied with the limited options that we have. And it’s their IRA, they can roll it over and do something else with it.”

In Oregon, the first state to begin implementing its automatic IRA program, more than 54,000 accounts have been created.

Those owners have saved a collective $36 million so far, Read said. In Illinois, about 24,000 private sector workers saved $5 million by the beginning of September through Illinois Secure Choice.

California’s CalSavers had enrolled about 2,200 residents in the first three months, the last time the state reported data.

The investment options in each case are basic. In Oregon, the first $1,000 invested goes into a low-yield, low-risk capital preservation fund. Residents can opt to invest in an S&P 500 index fund or in target date funds that adjust investment risk levels based on when someone plans to retire.

But the results are proving popular among Oregon voters. A poll conducted in Oregon for the AARP found 82 percent of state residents support the idea of an automatic savings plan.

About a dozen other states are either studying their own version of the automatic retirement plans or moving to implement pilot programs, Antonelli said.

They range from states led by conservative legislatures like Idaho, Wisconsin and North Carolina to bluer states like New York, Maryland and Connecticut. Seattle has already implemented a similar program, and New York City is considering its own version.

The states themselves see benefits to a workforce that is better prepared for retirement. The more someone saves, the less likely they are to rely on government services, Antonelli said.

“The state is just making it much easier to connect the worker to the IRA,” she said. “The consequences for state budgets as well as the national budget in terms of safety net services are enormous.”

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