In December 2019, the federal government passed into law a set of reforms designed to help Americans achieve retirement security
The legislation—known as the Secure Act—broadens access to tax-advantaged retirement-savings accounts and lets Americans keep money in such accounts longer, among other things.
In recent months, worries about Americans’ retirement security have been heightened by the coronavirus pandemic. The mass unemployment caused by Covid-19 is a reminder of why people need retirement savings in the first place.
So how consequential is the Secure Act? And how can its provisions help workers navigate the current economic downturn?
From the perspective of behavioral economics, the Secure Act corrects some of the blind spots people have when it comes to saving for retirement. But it doesn’t go far enough. Policy makers can and should do more to help people overcome the psychological obstacles that keep them from saving.
The Secure Act builds on 2006 legislation that helped establish the “autopilot” model of retirement saving in which workers, unless they opt out, are auto-enrolled in a retirement plan, auto-escalated to higher savings rates and auto-invested in a well-diversified portfolio. Such an automatic model turns inertia into an advantage, as most workers accept the default settings.
The Secure Act cleared the way for more workers to benefit from this autopilot model of savings by requiring that employers open their retirement plans to part-time workers who have worked more than 500 hours annually for three or more consecutive years. This provision may be particularly important in light of the Covid-19 crisis, as many full-time workers have had their hours significantly reduced.
The law also raises the cap on auto-escalated savings rates to 15% from 10%. With many workers struggling to save anything in the current downturn, let alone 15% of their salaries, this provision might seem irrelevant. But it is actually more critical than ever because once the crisis has passed, many workers will need to save at a higher rate to catch up and achieve financial security.
That brings us to the most treacherous phase of the retirement journey—the “landing.” Known as decumulation, this is when retirees start drawing down their assets. This phase requires people to make a series of complex and often irrevocable decisions that, if done wrong, could lead them to run out of money.
Many of the most important elements of the Secure Act focus on helping workers nail this landing.
Let’s start with the illusion of wealth. When workers look at their retirement savings, they are often reassured by the size of the total balance. My research with Dan Goldstein at Microsoft Research and Hal Hershfield at UCLA, for instance, shows that most people think $100,000 is a sufficient amount of savings. However, when they are told that the lump sum translates into roughly $500 a month in retirement, those savings seem much less adequate.
To help people overcome the illusion of wealth, the Secure Act mandates that retirement-plan providers display participants’ savings in term of projected monthly income, not just total assets. This gives workers a better sense of whether they need to save more or work longer to maintain their standard of living in retirement.
Another important behavioral challenge for decumulation involves predicting longevity, which affects how long a saver’s money has to last. Workers’ predictions of how long they will live are often inconsistent and dependent on how the question is framed. But considering that a third of 65-year-olds will live past 90, according to the Social Security Administration, most people should at least take into account the possibility of living for more than 30 years in retirement.
The Secure Act provides a small, but much-needed reminder of this by pushing back the maximum age at which people have to start taking retirement-plan withdrawals, to age 72 from 70½. This 18-month extension could help get more people thinking about longevity when making decumulation plans. After all, one of the main reasons to delay withdrawals is to avoid running out of money if you live longer than expected.
The last behavioral obstacle the Secure Act tries to address is choice overload, which keeps many workers from considering annuities. These products, which in essence convert a lump-sum amount into a guaranteed stream of income in retirement, can be a useful way to deal with the challenges of decumulation.
For many Americans, the recent economic crisis is a reminder that the guaranteed income provided by annuities is worth considering. In a world full of uncertainty, annuities can help provide some financial stability.
Few Americans buy annuities, however, partly because most 401(k) plans don’t offer them. The Secure Act removes some barriers that have prevented companies from offering annuities in 401(k) plans, thus making it easier for people to consider these financial products.
Taken together, these reforms are useful, but there is still plenty of room for improvement.
One critical element that’s missing is increased personalization, or tailoring recommendations for individual savers.
Let’s start with the cap on auto-escalated savings rates. In the digital age, it’s relatively easy to generate a personalized accumulation plan, based on your savings balance, age and when people like you tend to retire. For workers who start saving later, an 18% cap might be more appropriate than a 15% cap. The law should encourage a personalized test based on income replacement, rather than broad rules that might leave some people behind.
The same principle applies to the maximum age for required minimum distributions, or RMDs. Instead of setting the age at 72 across the board, perhaps policy makers should tailor it to the individual. Why should a healthy 72-year-old who is still in the workforce be forced to withdraw too much too soon, raising the risk he or she might outlive their savings?
Some might argue that personalized assessments of longevity could involve sensitive medical information. That’s true, but we could design the system on an opt-in basis, so that only those applying for a withdrawal extension would be asked for the information. In this sense, it would be similar to applying for life insurance.
Another objection is that allowing people to delay withdrawals will lower tax revenues. Because the Secure Act was designed to be “revenue-neutral,” this would require new tax revenue to offset those losses. It’s a fair point, but I believe it could be managed by using behavioral science to improve tax compliance.
Personalization also could help people choose the right annuities. Annuities are complex products, so even if annuities are included in more 401(k) plans, people might have a hard time choosing one.
Policy makers could help in this regard by encouraging employers to steer workers into appropriate annuities based on key financial, health and demographic factors. For instance, a single retiree might be presented with single life annuities rather than joint life, while someone who has had a heart attack could be offered enhanced annuities, which provide higher monthly payments for those with shorter expected lifespans.
I also wish the Secure Act used a broader toolbox of incentives. The new law focuses almost exclusively on tax credits to accomplish its policy goals when there are often more efficient ways to influence behavior.
The new law, for example, offers small businesses a higher tax credit for offering a retirement plan to workers. That’s nice, but the majority of small businesses either break even or lose money, thus pay minimal taxes already.
What’s more, tax incentives in general may be an inefficient way to nudge behavior, at least relative to other digital nudges. In a study conducted with the Department of Defense, my colleagues and I showed that an email that made it easier for people to enroll in a savings plan was 100 times more cost-effective than interventions such as tax incentives. It’s often better to make it easy than to make it free.
Scientists also are increasingly finding that nonmonetary rewards can be extremely motivating. Jana Gallus at UCLA, for instance, has shown that purely symbolic rewards can dramatically increase the retention of new editors on Wikipedia. Should regulators consider using symbolic rewards for businesses that offer suitable retirement plans?
Regulators, for example, could work with industry associations to link a 401(k) with the right autopilot settings to ESG certification, which identifies companies that meet certain environmental, social and governance benchmarks. Retirement plans could be a feature of the social certification, as we know that auto-enrollment can dramatically reduce social gaps in saving behavior.
Given the cost of recent coronavirus-related stimulus bills, and increased government debt, it’s more important than ever that we learn how to spend tax dollars as efficiently as possible.
If the Secure Act were passed 20 years ago, it would be a more consequential piece of legislation. In 2020, however, we have many more insights, nudges and technological tools that can be used to help people on their retirement journey.
Let’s put them to use.
Dr. Benartzi (@shlomobenartzi), is a professor and co-head of the behavioral decision-making group at UCLA Anderson School of Management and a frequent contributor to Journal Reports. Email him at firstname.lastname@example.org.