This weekend, the President announced a handful of new initiatives designed to make it easier for American workers to save more for retirement. The initiatives make use of research from behavioral economics, the arm of the dismal science that incorporates the way people really act into the design of retirement plans. That has proven extremely effective in the past ... except this time the Administration loses its nerve.
The new initiative does four things:
Let employers more easily enroll workers automatically in the company's 401(k) or SIMPLE-IRA. This is mainly a boon to younger employees, who have a disturbing tendency not to sign up for plans voluntarily. The Administration's idea is to use the most powerful force in personal finance inertia to help those younger employees do the right thing in spite of themselves. With automatic enrollment, the company signs you up and starts putting money from your paycheck into your 401(k) without asking your permission. You can always opt out, but as behavioral economics predicts, few do. Inertia, you know.
Make it easier to save tax refunds. The new rule will allow you to use your income tax refund to purchase U.S. Savings Bonds. Nice impulse, but savings bonds are not the right investment for a long-term goal. You're better off shipping the money to an IRA, if you're not already over 2009's $5,000 contribution limit.
Make it possible to save unused leave and vacation pay in your 401(k). This is the money you get for the vacation days you didn't have a chance to take before your employer canned you. Since no one counts on earning vacation pay -- you never see it in cash until the company is showing you the door -- it's psychologically easier to set aside. In theory. Problem is, when you lose your job in this economy, you're probably going to want the cash now rather than an opportunity to stash it away for decades.
Create "plain English" explanations of your options when you leave a 401(k) plan. The Administration promises to create easy-to-understand explanations of why you shouldn't make one of the dumbest of all financial moves: taking money out of a 401(k) you are leaving, rather than rolling it over into an IRA or a new 401(k). If you make that mistake, not only do you lose your savings, but you pay a huge tax bill for the privilege.
Unfortunately, behavioral economics doesn't offer much support to the idea that investor education -- however plain its English -- can change human tendencies. Maybe a few people don't already know it's bad to gut their 401(k) between jobs, but I think their main motivation is that they simply find it too tempting to lay their hands on so much money at one time. In other words, it's not that people don't understand that they shouldn't cash out their 401(k)s; it's that they lack the self-control not to.
If the Administration really wanted to stop the leakage from 401(k) plans, it whould have the courage of its behavioral economic convictions and simply make it impossible to get at the money except in real emergencies. You don't get smokers to quit by showing them plain-English graphs proving that smoking eventually has a suboptimal influence on your health. You just lock up the cigarettes.
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