Persistent anchoring to default rates when electing 401(k) contributions

Abstract

Purpose The purpose of this paper is to investigate how the 401(k) auto-enrollment rate influences the size of elected contribution rates in defined contribution plans for new, young enrollees. Design/methodology/approach The authors survey 324 undergraduate students at a mid-sized Midwestern university, and compare the elected contribution rates for two groups who were randomly given two default rates: 3 and 15 percent. Findings The results indicate widespread evidence of the anchoring and adjusting heuristic in regards to the provided auto-enrollment rate, as the 3 percent default rate group selects a contribution rate of approximately 2 percent less than the group that was provided with the 15 percent default rate. The results also provide support to the benefits of financial education: those who were taking or had already taken a college-level finance course provide higher contribution rates by about 1.7 percent overall. Additionally, individuals with the lowest critical thinking skills elect approximately 2 percent less in annual contributions overall than those who demonstrate higher critical thinking skills. Originality/value Interestingly, all groups seem to be susceptible to the anchoring and adjustment heuristic, as the default rate plays a significant role in the elected contribution rate, regardless of an individual’s financial sophistication or critical thinking skill level. The authors hope that these findings prompt benefit plan administrators and policy-makers to reconsider default rates in their retirement plans that would allow for maximum savings and participation rates. The findings also speak in favor of developing programs that would assist enrollees with financial education and critical thinking skills that would yield better retirement savings decisions when asked to make their employee benefit selections.

Automatic Enrollment with a 12% Default Contribution Rate

“…Camilleri et al (2019) find that approximately half of the participants in their online experiment accept the default investment option in a simulated lifecycle portfolio choice problem. Foltice et al (2018) demonstrate in a laboratory experiment that changing the default contribution rate from 3% to 15% increases participants' mean chosen contribution rate from 7.3% to 9.2%. We chose not to include these two articles in Table 1 because they involve subjects making hypothetical decisions and might therefore be less predictive of workers' behavior in defined contribution plans than field data.…”