Salesmanship needs to be applied to savings message

Author: David Nicklaus

Published: May 15, 2005

AMERICANS ARE woefully underprepared for their golden years. According to Peter Orszag of the Brookings Institution, half of households on the verge of retirement have less than $10,000 in savings.

With company pensions disappearing and Social Security looking creaky, that's clearly not enough. But if people aren't responding to the incentives already contained in the tax code, how can they be convinced to save more?

A new study suggests some answers: Provide better incentives, and apply a dose of salesmanship.

The savings shortfall is particularly severe among low-income people. Orszag, who participated in the study, says they don't find traditional tax incentives very compelling. Some owe no income taxes at all and others are in the 15 percent bracket, where a deduction for contributing to an Individual Retirement Account isn't very lucrative.

The study, conducted at 60 H&R Block offices in St. Louis by a group called the Retirement Security Project, tried to see what a big, immediate incentive would do to savings behavior.

On a random basis, some H&R Block tax clients were offered a 50 percent match for the first $1,000 they contributed to an IRA. Others got a 20 percent match, while some got nothing.

The experiment worked, to a degree. Only 3 percent of the no-match group opened an IRA, and participation rose to 17 percent when people got a $50 reward for every $100 they saved.

But cash wasn't the only thing that determined who saved and who didn't. Some tax professionals were better than others in convincing their clients to take advantage of the incentives.

The tax preparers all got the same training on how to run the experiment, but some had more experience with a product that H&R Block calls the Express IRA. It lets a client route his or her tax refund into an IRA bank account.

The tax preparers with more IRA experience were significantly more successful at selling clients on the benefits of a 20 percent or 50 percent match. That's an important lesson.

"Savings behavior is influenced by much more than rates of return and marginal tax rates," said Jeffrey R. Brown, assistant professor of finance at the University of Illinois. "Institutional factors matter a lot, how savings is sold matters a lot, and simplicity is important."

The upfront match appeared to get a higher response rate than the Saver's Credit, one incentive that our current tax code offers to low-income people. The credit, which is set to expire next year, is available to married couples earning less than $50,000 a year and to single people earning less than $25,000.

They get a credit as high as 50 percent on contributions to an IRA or 401(k). But the credit is nonrefundable, so it's not attractive to people who don't think they'll owe any federal income taxes.

"The experiment explains the incentive in a very simple way and makes it available to all taxpayers, whereas the Saver's Credit is very hard to understand and use," said William Gale, a Brookings senior fellow. "Transparent and understandable financial incentives matter."

Cold, hard cash certainly is transparent and understandable. But what's troubling is this: Even with the strongest of incentives, 83 percent of people in the study group decided not to save. Some said they had already spent their refunds, and others thought the offer sounded too good to be true.

"The general state of financial readiness and financial literacy is unfortunately low," said Bernie Wilson, an H&R Block vice president. "What that low literacy does is create suspicion and fear, and people freeze. They choose to keep the status quo and not start saving."

That, unfortunately, sounds like a problem that won't be fixed with cash alone.