Tax Policy Center | Urban Institute and Brookings Institution

The Automatic 401(k): A Simple Way To Strengthen Retirement Saving

William G. Gale, J. Mark Iwry, Peter Orszag

Published: March 07, 2005
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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

© TAX ANALYSTS. Reprinted with permission.

Note: This report is available in its entirety in the Portable Document Format (PDF).

I. Introduction

Over the past quarter-century, private pension plans in the United States have trended toward a do-it-yourself approach in which covered workers bear more investment risk and make more decisions themselves about their retirement savings. Some workers have thrived under this more individualized approach, amassing sizable balances in 401(k) plans and similar plans that will assure them a comfortable and relatively secure retirement income.

For others, however, the 401(k) revolution has fallen short of its potential. Work, family, and other more immediate competing demands often distract workers from the need to save and invest for the future. Those who do take the time to consider their choices find the decisions they face to be quite complex: Individual financial planning is seldom a simple task. For many workers, the result is poor decisionmaking at each stage of the retirement saving process, putting the level and security of their retirement income at risk. Even worse, in the face of those difficult choices, many people simply procrastinate and thereby avoid dealing with the issues altogether, dramatically raising the likelihood that they will save inadequate amounts for retirement.

A disarmingly simple concept — what we call the automatic 401(k) — has the potential to cut through that Gordian knot and improve retirement security for millions of workers via a set of common-sense reforms. In a nutshell, the automatic 401(k) consists of changing the default option at each phase of the 401(k) savings cycle to make sound saving and investment decisions the norm, even, and especially, when the worker never gets around to making a choice in the first place. Given the current structure of most 401(k) plans, workers do not participate unless they actively choose to. In contrast, under an automatic 401(k) they would participate unless they actively choose not to — and similarly for each major decision thereafter. Contributions would be made, increased gradually over time, invested prudently, and preserved for retirement, all without putting the onus on workers to take the initiative for any of those steps. At the same time, however, workers would remain free to override the default options — to choose whether or not to save, and to control how their savings are invested — but those who fail to exercise the initiative would not be left behind.

The steps involved in building an automatic 401(k) are not complicated and the benefits could be substantial; indeed, a growing body of empirical evidence suggests that the automatic 401(k) may be the most promising approach to bolstering retirement security for millions of American families. A number of economists have undertaken important research and contributed practical suggestions concerning the actual and potential uses of automatic enrollment and related default arrangements in 401(k) plans.1 Drawing on their contributions, this article describes the motivation for, the features of, and the potential benefits of the automatic 401(k).

Notes from this section

1 William G. Gale is deputy director of the Economic Studies Program at the Brookings Institution, the Arjay and Frances Fearing Miller chair in Federal Economic Policy at Brookings, and codirector of the Urban-Brookings Tax Policy Center. J. Mark Iwry is senior adviser to the Retirement Security Project, a nonresident senior fellow at Brookings, and the former benefits tax counsel at the U.S. Treasury Department, where he played a lead role in developing the saver’s credit and automatic rollover and in approving and advancing automatic enrollment. Peter R. Orszag is director of the Retirement Security Project, the Joseph A. Pechman Senior Fellow in Tax and Fiscal Policy at the Brookings Institution, and codirector of the Urban- Brookings Tax Policy Center. The authors thank Melissa Green, Lori Lucas, Brigitte Madrian, Alicia Munnell, Kathy Stokes Murray, and Richard Thaler for helpful comments, and Matt Hall for outstanding research assistance. The Retirement Security Project is supported by The Pew Charitable Trusts in partnership with Georgetown University’s Public Policy Institute and The Brookings Institution.

Note: This report is available in its entirety in the Portable Document Format (PDF).

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