In our last article, “Spending Behavior May Be Key to Retirement Savings: Research Results,” we discussed the findings from a research project undertaken by J.P. Morgan Asset Management (JPMAM) and the Employee Benefit Research Institute (EBRI). JPMAM published the results of their research in a June 3, 2020 paper entitled, “The 3% difference: What leads to higher retirement savings rates?” The research is groundbreaking in that it finally provides better insight into why some people save more than others. The following will offer commentaries on the implications of the research findings.

First, a quick summary of the research. The research population was broken into three saver profiles: Low Savers, Middle Savers and High Savers. For characteristics of each, refer to our last article. Interestingly, it turns out that meaningful differences in spending behavior—not salary differentials (i.e. the median salary levels for Low and Middle savers is substantially the same)—was suggested to account for the difference in median savings rates among the Low and Middle Savers. Based on this research, Low Savers aren’t saving enough because they spend too much. The obvious solution, therefore, is for Low Savers to spend less and then they would be able to save more.

How can one spend less and save more? The “rational” approach would be for an individual to make a detailed budget to determine what his or her spending needs are and how much could be saved for retirement. Spending would then be monitored to make sure the budget is adhered to. However, this task is something most people will not do. It will continually be put off along with the saving.

A better, more realistic approach is for the individual to make a ballpark estimate of what he or she thinks can be saved, and then to automate that saving. A 401(k) plan provides an excellent mechanism for doing this. The savings amount is automatically deducted from the paycheck and put into the 401(k) account. This requires the plan participant to get by with less spending. While this will not necessarily work for someone making just enough to meet essential living expenses, it will work for a large number of those employed. This approach does not require detailed budget spreadsheets and constant monitoring; it will just require a little upfront analysis.

Many 401(k) plans utilize plan design features to assist plan participants save. Features include automatic enrollment and escalation, and financial wellness programs. These plans make it easy to initiate and maintain a good savings program. Even if an employer’s 401(k) plan does not have these features, participants can still “self-impose” these features to achieve a successful outcome.

However, this naïve solution is easier said than done. What drives human behavior is a complex issue. Even when knowing the right or “rational” thing to do, humans have a number of psychological factors working against them. Knowing we should spend less and save more doesn’t necessarily result in that behavior.

How 401(k) Plans Help With Saving

The research found that the primary savings vehicle for most households is their 401(k) plan. These plans provide a convenient vehicle to enhance retirement savings. In particular, certain plan design features have been successful in improving participant outcomes. Three of these are:

1. Auto Enrollment Features: There are three key features with automatic enrollment:

  • A participant is automatically enrolled in the plan after they meet the eligibility requirements. If an employee does not want to participate, they need to “opt-out.”
  • A default contribution rate is utilized. If the employee does not indicate a different rate, then the default is used. Typically, the default rate ranges from 3% to 5%.
  • A default investment option is utilized, most often a “Target Date Fund.”

The key to automatic enrollment is that the employee does not need to do anything and they will be enrolled in the plan at the default contribution rate and investment option. Participants that have access to a plan that offers this feature, should make sure they don’t “opt out.” The one variable they may want to consider is the default rate. For example, if a participant doesn’t think he or she can afford to contribute at the default rate, then a lower rate can be requested instead of opting out of the plan completely. Conversely, if a higher rate can be contributed, then this should be requested.

2. Auto Escalation Features: Based on Vanguard’s report, “How America Saves 2020,” approximately two-thirds of plans with automatic enrollment utilize automatic escalation. As most know by now, auto escalation periodically increases a participant’s contribution rate (e.g. a 1% increase every year or timed to salary increases, subject to the right of the participant to opt out). The SECURE Act increased the cap from 10% to 15% on these auto increases, effective in 2020. This is another feature plan participants won’t want to opt-out of. Plans that don’t utilize automatic escalation often offer it on a voluntary basis. Even if neither of these options are available, one should consider evaluating his or her contribution rate once a year or at the time of a raise.

3. Financial Wellness Features: Financial wellness programs for 401(k) plans are still in the early stages of development and deployment. The key objective of these programs is to provide assistance to employees in making better financial decisions and, in so doing, helping them achieve financial wellness. The Retirement Advisor Council defines the goal of financial wellness programs as follows:

Support the overall financial health of employees by providing tools and resources to help employees manage their current finances, prepare for financial shocks and plan for their retirement and financial future.

The better programs achieve this goal by providing services such as financial education, budgeting assistance, retirement readiness assessment and individual coaching. They also offer tools for goal tracking, decision analysis and performance assessment. This seems to be a good mechanism to help participants optimize their saving and spending. For example, features of these programs may improve decision making with large purchases (think housing, cars and education), retirement saving and financial matters in general. Methods of providing this assistance include targeted education, as well as “just-in-time” advice, whether digital or live.

If the plan participant’s plan offers such a program, then the participant should be sure to take advantage of what it has to offer.

The findings published by JPMAM bring to light the probable importance of spending behavior in saving for retirement. The gap between Low and Middle Savers may be reduced by incorporating some or all of the suggestions presented here. These suggestions provide ideas on how to increase the retirement savings rate, as well as promote overall financial wellness. The suggestions here should be assessed in light of the plan participant’s particular circumstances.

If you have any questions or comments on employee benefit plan matters, please call or email Rich Baker. He can be reached at 415.869.5578 or