$100 Dollar Bills on the Sidewalk: Sub Optimal Savings in 401(k) Plans (Choi et al., 2005) Presented By Sylvia Sirivar and Ruth Gbor

Objectives of Study To explain the forgone opportunity of not contributing to 401(K) up to the employer match threshold. To highlight the fact that there is no loss of liquidity from contributing up to the match threshold To see if education can raise the level of contribution among employees who were 59.5 yrs old and older

Rationale of Sample A series of year end cross sections on all employees at seven firms from 1998 to 2002 The seven firms were selected because they offer an employer match and it is possible for employees over the age of 59.5 to make discretionary, penalty-free, in service withdrawals

Rationale cont’d employers offered a matching contribution proportional to the employees own contribution up to a threshold and allowed employees older than 59.5 to withdraw the maximum gain from the company match in the sample is 6% of annual salary at company A who are matched at 100% of their contribution up to 6% of their pay, this company was the focus of the experiment

Rationale Cont’d the selection of the sample, especially the age of participants was designed to maximize the attractiveness of the plan, because this age group was more likely to be fully vested, and to be able to enjoy liquidity penalty free. In contrast younger employees would not be able to enjoy this benefit because of constraints such as length of tenure to be considered fully vested

Findings from study Perceived transaction cost and satiation not reasons for failure to contribute up to the employer match threshold. Dominant strategy was contribution below the threshold match. Employees contributing less than the match contribution are more likely to forfeit other benefits as well

Free Money to Employees (>59.5yrs) Contributing to 401(k) Employee contributes additional money to the match threshold Employer matches employee contribution at the match rate Employee withdraws additional contribution made with no penalty Employer’s match still remains for employee - “$100 Bills on the sidewalk” (Windfall money)

How much will employees be losing if not contributing to the max? Choi, Laibson and Madrian (2005) The average forgone match in 1998 is $250 or 1.3% of annual pay

Possible Explanations to Findings Employees vesting status and perceived length of future tenure at the company Differences in financial literacy and contribution rates were directly related –Only 8% of under savers responded they are knowledgeable investors compared to 20% of those contributing at or above the match threshold. –Under savers incorrectly believe their own employer’s stock to be less risky than a large U.S. stock mutual –Many under savers could not mention the employer match rate and threshold amount

Possible Explanations to Findings - cont’d Procrastination –Average days taken to return survey by people contributing at or above the match threshold were less (15.1) than employees contributing below the match threshold (17.2) –More employees contributing at or above the match threshold (higher group median income) collected $50 to fill the survey than did employees contributing below the match threshold

Critique of the article Response rate to the survey was so low (26%). To use such a low response rate (Small sample) to generalize findings may not reflect the actual cause of employee lack of interest for not taking advantage of the employer match threshold. Not knowing the indirect cost of participating in the savings plan does not make the study complete (i.e. figuring out the optimal contribution rate and the allocation of assets).

Recap of Findings Improvements in Financial literacy had a negligible effect on ameliorating sub-optimal savings behavior, and few employees altered their behavior and failed to contribute up to the employers matching threshold; the authors controlled for the effects of incomplete vesting (they were over 59.5 years which meant they were fully vested, liquidity constraints (they were allowed to withdraw their money before retirement) and early withdrawal penalties.

Policy Implications people often act in ways that run counter to their best interest when it comes to saving for their retirement because of the compelling influence of cognitive biases such as the “status quo” bias, which are often in conflict with rational cognitive processes.

Nudge Educational interventions are not a big enough “nudge” to induce people to act in ways that promote their economic best interest when it comes to saving for retirement What policy measures can be implemented to counter act the influence of our “inner lizards”?