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Financial Analysts JournalVolume 69 Number 32013 CFA Institute

P E R S P E C T I V E S

Mandatory Retirement Savings

Meir Statman

Nudges toward voluntary defned-contribution retirement savings have transormed many nonsavers intosavers but have let many behind. The author argues that it is time to switch rom libertarian-paternalisticnudges to ully paternalistic shoves. He advocates a retirement savings solution centered on a paternalisticsecond layer omandatory private defned-contribution savings accounts in a retirement savings pyramid,above the paternalistic frst layer o Social Security and below the libertarian third layer o voluntary savings.

Savers are on their way to adequate retire-ment income, whereas nonsavers arelikely to subsist on Social Security benets.

Libertarian-paternalistic nudges have movedmany nonsavers into dened-contribution retire-ment savings but have let many behind, includingthose with limited access to such savings plans. Itis time to switch rom nudging to shoving nonsav-ers into savings plans and to replace libertarian-paternalistic voluntary dened-contributionaccounts with ully paternalistic mandatory dened-contribution accounts or all.

These mandatory savings accounts would be

private accounts, much like current 401(k) accountsand IRAs except that they would be mandatoryand unavailable or distribution beore retirementage. They would constitute a paternalistic middlelayer in a retirement savings pyramid, above thepaternalistic layer o mandatory Social Securityand below the libertarian layer o voluntary sav-ings. Mandatory savings accounts would providea great benet to nonsavers who ail to accumulatesucient retirement savings while adding no bur-den or savers because they would largely replacevoluntary 401(k) and IRA savings. Indeed, manda-

tory dened-contribution accounts would benetsavers by alleviating the burden on adult childrenwho support destitute nonsaving parents and the

burden on taxpayers who support destitute non-savers through taxes and transer payments.

Mandatory dened-contribution savingsplans exist in several countries outside the UnitedStates and at universities in the United States.These plans hold lessons about plan eatures that

we would be wise to adopt and faws that wewould be wise to avoid.

Savers, Nonsavers, Sel-Control,

and External ControlMany savers accumulate much more than theyneed in retirement. Poterba, Venti, and Wise (2011)ound that most savers barely tap their retirementsavings accounts, such as 401(k) plans, much lessdeplete them. But nonsavers are in trouble. Jacobe(2012) reported on a Gallup poll that revealedthat Americans underestimate their likely reli-

ance on Social Security: Among nonretirees, only33% expected Social Security to be a major retire-ment unding source, but 57% o retirees reportedthat Social Security is a major source o retirementunding.

Income is the source o savings, yet even highincomes do not ensure savings because spendingtemptations abound. Each o us is born with thecapacity or sel-control, just as we are born withthe capacity or language, but some are born with agreater capacity than others. Analyzing the saving

behavior o identical and raternal twins, Cronqvist

and Siegel (2010) ound that genetics account orapproximately one-third o the dierences in sav-ing behavior. The eect o parents on their chil-drens saving behavior is strongest when childrenare in their 20s but disappears by middle age.

Conscientiousness, closely related to sel-control, is one o the Big Five actors o personality,along with extraversion, openness, agreeableness,and neuroticism. Conscientious people do not

buy things on impulse, spend too much money,or buy things they do not really need. Duckworthand Weir (2011) noted that conscientiousness is

Meir Statman is the Glenn Klimek Proessor o Financeat Santa Clara University, Santa Clara, Caliornia.

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the personality actor most closely related to aca-demic achievement, job perormance, marital sta-

bility, and longevity. They ound that conscientiouspeople accumulate more wealth than less conscien-tious people, even ater accounting or dierencesin income, education, and cognitive ability.

A mandatory retirement savings plan bolsters

savings by limiting the income available or spend-ing, replacing sel-control with outside control, andimposing conscientious behavior on those lackingconscientiousness.

The Changing Retirement SavingsPyramidThe U.S. retirement savings pyramid used to becomposed o Social Security as the bottom layer,dened-benet pensions as the middle layer, andpersonal savings as the top layer. Social Securityis mandatory and personal savings are voluntary.

Voluntary dened-contribution savings plans havenow replaced many dened-benet pension plans asthe second layer o the retirement savings pyramid.

Yearning or the good old days o dened-benet pension plans leaves the impression thata time when everyone was covered by a comort-able pension blanket indeed existed. But such daysnever existed, surely not or everyone. Butrica,Iams, Smith, and Toder (2009) noted that only 38%o workers participated in dened-benet pensionplans in 1980. The portion o workers participatingin such plans had declined to 20% by 2008.

We may bemoan the passing o dened-benetpension plans, but we cannot save them. Corporatedened-benet pension plans will continue toshrivel rather than thrive, and so will public sec-tor dened-benet pension unds, especially nowthat we know the extent o their underundingtrillions o dollarsand the inherent conficts theypose. Beshears, Choi, Laibson, and Madrian (2011)noted that although dened-benet pension plansare still the primary type o retirement plan or alllevels o state and local government, 11 states andWashington, DC, have dened-contribution com-ponents in their retirement plans and some states

have recently decreased the generosity o theirdened-benet plans.

Nudging Nonsavers toward

Voluntary SavingsMuch eort has gone into increasing retirementsavings by choice architecture, nudging nonsaversinto saving through the prescriptions o Thaler andSunstein (2008). Automatic enrollment is a promi-nent eature o choice architecture, and Madrianand Shea (2001) ound that it increased participation

in a dened-contribution plan. Yet, more than 20%o employees with incomes lower than $20,000did not enroll even when enrollment was auto-matic. Moreover, Bronchetti, Dee, Human, andMagenheim (2011) ound that nudges are largelyineective among the poor. In a eld experiment,they divided low-income tax lers into two groups.

People in the rst group could opt in to receivesome o their ederal tax reund in the orm o U.S.savings bonds. People in the second group werenudged toward saving; a raction o their tax reundwas automatically directed to U.S. savings bondsunless they actively chose to opt out. Bronchetti et al.ound that the opt-in deault had no impact on sav-ing behavior, likely because low-income people hadplans to spend their reunds rather than save them.

Employees o companies without dened-contribution savings plans, employees who do notenroll in available dened-contribution savingsplans, employees who enroll but contribute little,

and employees who cash out beore retirement aredoomed to live in retirement on little beyond SocialSecurity benets.

The lack o nancial literacy hampers nonsav-ers, perhaps obscuring the likelihood o destitu-tion in retirement. Lusardi and Mitchell (2005)ound that nancial literacy is lacking among olderAmericans and that the nancial literacy o women,minorities, and those without college degrees isparticularly decient. Financial literacy is no bet-ter outside the United States. Yet, as Willis (2011)noted, research ails to demonstrate that nancial

education leads to greater nancial literacy, betternancial behavior, or improved nancial outcomes.

Mandatory Defned-Contribution

Savings Plans in Australia, Israel,

and the United Kingdom and at U.S.

UniversitiesSuperannuation is Australias mandatory dened-contribution retirement savings plan. Currently,employers contribute 9% o employee earnings on

behal o their employees. This level will gradually

increase to 12% by 20192020. Employees can vol-untarily contribute to the superannuation program

beyond the mandatory 9%, and such contributionsaverage 3%. Tax provisions encourage people towithdraw their money gradually ater age 60,rather than in a lump sum.

Most Australian superannuation unds are man-aged on a or-prot basis by nancial institutions oron a not-or-prot basis by employers or a combina-tion o employers and trade unions. Employees canchoose among unds, but und costs are generallyhigh. Bird and Gray (2011) estimated that employees

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would earn an additional 23 percentage pointsannually i they were to substitute low-cost indexunds or high-cost active unds.

The mandatory dened-contribution retire-ment savings program in Israel totals, at a mini-mum, 18.33% o employee earnings. It is composedo three parts: an employer contribution ranging

rom a minimum o 5% o earnings to a maximumo 7.5%, an employee contribution ranging rom 5%to 7%, and an additional employer contribution o8.33% that serves as severance pay i an employeeis laid o but is available to retiring employees whoare not laid o. Israeli employees can choose amonginvestment options managed by or-prot institu-tions and can negotiate ees. Employees receivetheir retirement savings in the orm o annuities

but can receive them in a lump sum i they provideevidence o sucient resources beyond mandatorysavings to sustain them in retirement.

The U.K. National Employment Savings Trust(NEST) is a mandatory dened-contribution retire-ment savings plan introduced in October 2012.According to Pechter (2012), the typical NESTparticipant is expected to be a nonsaving, rela-tively young, and low-income male. Employersare required to contribute to NEST at least 2% oemployee earnings in the 201213 tax year, andemployees are required to contribute at least1%. Mandatory contributions are scheduled toreach a total o 8% by 2018, composed o 3% romemployers, 4% rom employees, and 1% romthe government. Although employees can reuse

auto-enrollment in NEST, they are automaticallyenrolled every three years.

The deault oerings o NEST are 46 target-dateunds (TDFs) set in one-year intervals, making port-olio transitions smooth relative to portolio transi-tions in the United States, where TDFs are typicallyset in ve-year intervals. Centralized investmentmanagement is one eature o NEST, and very lowees are another. Investment and administrationees paid by NEST participants total 30 bps.

U.S. universities and certain other not-or-protinstitutions have had dened-contribution retire-

ment savings plans, typically 403(a) and 403(b)plans, or much longer than 401(k) and IRA planshave existed. The Carnegie Foundation or theAdvancement o Teaching established the TeachersInsurance and Annuity Association (TIAA) in 1918,refecting Andrew Carnegies concern about collegeteachers retirement savings. The College RetirementEquities Fund (CREF) supplemented the TIAA xed-income und starting in 1952. TIAA-CREF continuesto provide dened-contribution plans at universi-ties but has been joined by other providers, such asFidelity and Vanguard.

Formally, the dened-contribution retirementsavings plans at universities are not mandatory, butthey resemble mandatory plans because employersmake core contributions with no requirementthat employees make contributions. Ragnoni (2012)reported that core employer contributions average10.1% at private universities and 9.5% at public

ones. Some universities also mandate contributionsby employees, averaging approximately 5%, or atotal o approximately 15%. The expense ratios oTIAA-CREFs unds are relatively low, and someother providers oer unds with very low expenseratios, including index unds with expense ratioslower than 10 bps.

A Mandatory Defned-Contribution

Retirement Savings PlanI advocate a mandatory dened-contribution retire-ment savings plan with the ollowing eatures:

1. Combined mandatory contributions byemployers and employees amounting to a min-imum o 12% o earnings, equal to the percent-age set in Australia or 20192020. A minimumo 15%, common at many U.S. universities,would be even better.

2. Administration by companies oering 401(k)and similar plans but with an added centralagency to administer plans or employeeswhose employers do not provide dened-contribution retirement savings plans.

3. Deault oerings o well-diversied target-dateunds set in one-year intervals, as in the U.K.NEST program.

4. Fees not exceeding 30 bps, as in the U.K. NESTprogram. Low ees would naturally discour-age oerings o active unds promising posi-tive alphas. Although it is possible or a smallgroup o investors to enjoy positive alphas atthe expense o other investors who suer nega-tive alphas, it is inconceivable that on average,the very large group o owners o retirementsavings accounts would receive positive aver-age alphas. Instead, money destined or retire-

ment savings would likely be squandered inthe pursuit o positive alphas.

5. No borrowing rom retirement savingsaccounts and no cashing out o accounts beoreretirement age. Retirement savings would

be paid in annuities unless, as in Israel, ben-eciaries could show that they have sucientresources to sustain themselves in retirementeven i they withdraw their retirement savingsin a lump sum.

6. Enhanced nancial literacy through educa-tion at high schools and elsewhere. Financial

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literacy promotes wise nancial decisions, butpeoples retirement income should not be ham-pered by poor nancial literacy.

ConclusionThe retirement savings problem in the UnitedStates and many other countries is acute, and

attempts to nudge nonsavers toward voluntarydened-contribution savings have let many

behind. Moreover, many have no access to volun-tary dened-contribution savings plans. It is timeto switch rom libertarian-paternalistic nudges toully paternalistic shoves and replace libertarian-paternalistic voluntary dened-contribution sav-ings plans with ully paternalistic mandatorydened-contribution savings plans. Mandatory

dened-contribution plans would constitute a sec-ond layer in a retirement savings pyramid, above arst layer o Social Security and below a third layero voluntary savings.

People with no income will continue to haveno source or savings, and stock market crashesand raging infation can decimate accumulated

savings. But the problem o retirement income issevere, and solutions must be identied, debated,and implemented.

The author thanks Don Ezra, Tim Furlan, GrahamHarman, Kerry Pechter, Eyal Shlesinger, and LaurenceSiegel.

This article qualifes or 0.5 CE credit.

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Bird, Ron, and Jack Gray. 2011. A Brie Critical Review oAustralias Retirement Savings System. Journal o InvestmentConsulting, vol. 12, no. 2 (Winter):5358.

Bronchetti, Erin Todd, Thomas S. Dee, David B. Human, andEllen Magenheim. 2011. When a Nudge Isnt Enough: Deaultsand Saving among Low-Income Tax Filers. NBER WorkingPaper 16887 (March).

Butrica, Barbara A., Howard M. Iams, Karen E. Smith, and Eric J.Toder. 2009. The Disappearing Dened Benet Pension and ItsPotential Impact on the Retirement Incomes o Baby Boomers.

Social Security Bulletin, vol. 69, no. 3:127.

Cronqvist, Henrik, and Stephan Siegel. 2010. The Originso Savings Behavior. Working paper, Claremont McKennaCollege, Robert Day School o Economics and Finance.

Duckworth, Angela Lee, and David Weir. 2011. Personalityand Response to the Financial Crisis. Michigan RetirementResearch Center Research Paper WP 2011-260 (December).

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Pechter, Kerry. 2012. A New NEST or British Nest-Eggs.Retirement Income Journal (7 August).

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Ragnoni, John T. 2012. Dening Excellence: A Report onRetirement Readiness in the Not-or-Prot Higher EducationIndustry. Fidelity Perspectives (Winter).

Thaler, Richard H., and Cass R. Sunstein. 2008. Nudge: ImprovingDecisions about Health, Wealth, and Happiness. New Haven, CT:Yale University Press.

Willis, Lauren E. 2011. The Financial Education Fallacy.American Economic Review, vol. 101, no. 3 (May):429434.