The Secure Act 2.0 is a great start. But it is only just a start.
The bipartisan legislation recently signed by President Biden requires that all new retirement savings plans incorporate a savings autopilot starting in 2025. This means that workers are automatically enrolled in their retirement plans unless they opt out, and their savings rates are gradually escalated over time.
Working with Nobel laureate Richard Thaler, I’ve long argued that such savings autopilots are a powerful nudge, and that by changing the default of savings plans—that is, instead of giving savers the opportunity to opt in, they can opt out—we can make saving for the future the easiest choice.
This nudge has had a powerful impact. My latest estimate is that our auto-escalation nudge, known as Save More Tomorrow, has boosted the savings rates of more than 25 million Americans.
But this doesn’t mean our work is done. The Secure Act 2.0 is an important milestone, but I believe we can make additional changes in retirement plans that will make an even bigger difference for savers in all retirement plans, and not just new ones.
The Secure Act 2.0 suggests a minimum default savings rate of 3% for those auto-enrolled. That’s too low. Research I conducted with John Beshears at Harvard University and Richard Mason at Carnegie Mellon University shows that plans should auto-enroll people at a minimum savings rate of 7% if we want to maximize the savings that people will accumulate in their accounts, without decreasing participation.
Given the mobile American workforce—the median employee tenure is less than five years—it’s also important that we adjust the speed at which savings rates rise, so that people can reach a sufficient level quickly. Too often, people get to a higher savings rate, but then change jobs and get enrolled in their new plan at a low initial rate.
Preliminary research I’ve conducted with Saurabh Bhargava, Richard Mason and Mark Patterson at Carnegie Mellon demonstrates that it’s better to set the escalator to increase in annual increments of 2 percentage points (rather than 1 percentage point as the Secure Act 2.0 suggests), as this accelerates the pace of escalation for many workers without affecting the percentage of people who opt out.
We need to recognize that different employees can have very different financial circumstances and needs. That means tailoring an individual’s savings defaults to their specific financial situation. In this way, we can create smart defaults.
Take the example of a single parent with three children and five maxed-out credit cards who is struggling to pay off the minimum amount each month. Although I’m a leading proponent of savings autopilots, I’m an even bigger proponent of making sure our autopilots are smart and targeted. I wouldn’t automatically enroll this parent in a retirement plan at a 7%, or even 3%, savings rate.
Instead, he or she should focus on paying off expensive debt first. Put another way, employees should save less today, and even more tomorrow.
The larger lesson is that we should start automatically enrolling people at different rates. Some people might benefit from enrolling at 0% with a fast future escalator; others might benefit from an initial savings rate of 10%. In the aviation world, autopilots are customized based on the starting location and the planned destination. Our savings autopilots should do the same.
Consider that we’re already customizing investments based on employee differences. Younger employees, for instance, are often automatically invested in aggressive portfolios, while older employees are automatically invested in more conservative portfolios. I believe we should apply a similar level of personalization to other aspects of retirement-plan design.
The Secure 2.0 Act correctly recognizes that decisions about saving for retirement are bound up with other considerations, such as paying off student loans or putting money aside for a rainy day. For example, employees can choose to first pay off their student debt without losing the employer match, as the Secure Act 2.0 allows employers to match debt repayments with contributions to retirement savings accounts. As a result, people have far more flexibility when it comes to allocating their money.
That flexibility makes it possible to accommodate individual differences. Single parents, for instance, can now choose to save for emergencies before they begin saving for retirement. And a 72-year-old who is still working doesn’t have to start withdrawing from her IRA account, as the Secure Act 2.0 added the flexibility to defer the required minimum distributions to 75.
But all this flexibility comes with a catch: People will require additional guidance to take advantage it. In the 21st century, household finance has become incredibly complicated, which is why it’s so important to see the big picture when making financial decisions. Just look at the benefits decisions faced by new employees: They often have to make a dozen or so critical choices, from picking a dental plan to selecting a retirement savings rate. Making the right choice requires considering these options holistically, and not in isolation.
And let’s not forget employers, who also need guidance when setting defaults and limits. What should the default savings rate be for their employees? What’s the right emergency savings limit?
In my research, I’ve found that holistic financial guidance—advice that helps people deal with savings, debt and insurance, and not just investment portfolios—can be extremely valuable. For the typical employee, this big-picture advice is worth an income boost of 2.51%, or roughly 6.93% relative to their 401(k) account. Put another way, the value of the advice is worth roughly 7% of the median 401(k) account every year.
Where does that huge gain come from? It comes from eliminating costly mistakes and taking advantage of sure wins. For instance, many people select the wrong health-insurance plan, choosing to pay excessive premiums for slightly smaller deductibles. Or consider credit cards: Because people fail to pay down the cards with the highest interest rates first, they waste money on interest payments. Older workers, meanwhile, often fail to maximize their employer match, even though those who are 59½ years or older can withdraw those match dollars at any time without penalty. It’s a free lunch, and we should ensure that everyone gets it.
Unless we encourage employers to offer their workers holistic financial guidance, I’m afraid these new financial options made possible by the Secure 2.0 Act could have limited impact, or even backfire. Regulators have long been concerned about the cost of financial advice. But the absence of advice can be far more expensive.
The Secure Act has made behavioral economics the default framework for retirement plans. But a framework is just the start of the process. Now the real work begins.