Justifying Directional Nudges in Retirement Savings

Are People Saving Enough?

Sometimes good choice architecture is simply making life more navigable, making decision tasks as easy as following the directions on Google Maps. In such cases, the choice architect is not encouraging or discouraging any particular choice, but instead is just making the process of deciding and implementing as easy as possible. This approach often yields good outcomes. But other times the choice architect drops this goal of neutrality (which we know is impossible to achieve completely in any case) and decides to nudge directionally—that is, to gently encourage some choices and to discourage others. When is this sort of nudging warranted? There is no simple answer to this question, but recall: whenever we engage in directional nudging, we should be confident that we are likely to make people better off, as judged by them. Is helping people increase their retirement savings a legitimate goal?

A basic question one can ask about any retirement savings system (including both public and private components) is whether people are achieving the ultimate goal of having enough money to live comfortably after they stop working. This turns out to be a complex and controversial question, and the answers differ from one country to another. It is a hard question in part because economists do not agree about how much saving is appropriate—that is, what is the right level of postretirement income? Some economists argue that people should aim to have retirement income that is at least as high as the income enjoyed when working, because retirement years often offer the opportunity for time-intensive, expensive activities such as travel. In many countries, retired people also have to worry about growing health care costs. Other economists stress that retirees can use their greater leisure time to live a more economical lifestyle: saving the money once spent on business clothes, taking the time to shop carefully and prepare meals at home, and taking advantage of senior discounts. On the basis of these considerations, they would set a more modest savings goal.

We do not take a strong position on this debate, but consider a few points. First, it seems clear the costs of saving too little are usually greater than the costs of saving too much. There are many ways to cope with having saved too much—from retiring earlier than expected to taking up golf to traveling to exotic locations to spoiling the grandchildren. Coping in the opposite direction, meaning continuing to work or accepting a reduced lifestyle, is less pleasant. Second, some people are definitely saving too little—namely, those employees who are not participating at all in their retirement plan (or don’t even have such a plan available to join). We also worry about those who have reached middle age and have not managed to begin to establish a retirement nest egg, and may even have more debt than savings. These folks could clearly use a nudge.

For what it is worth, many employees themselves think that they should be saving more. In one study, 68 percent of the participants in a defined-contribution savings plan said that they consider their savings rate to be “too low,” 31 percent said that their savings rate is “about right,” and only 1 percent said their savings rate is “too high.” [2] Economists tend to belittle such statements, and partly for good reason. It is easy to say that you “should” be doing many good things—dieting, exercising, spending more time with your children—but people’s actions may tell us more than their words. When people say they should be saving more, they might not be thinking that they should be spending less; they might just mean it would be nice to have more money in the bank.

Indeed, few of the participants who said they should be saving more actually did make changes in their behavior. But such statements are not meaningless or random. Many people announce an intention to eat less and exercise more next year, but few say they hope to smoke more next year or eat more potato chips. We interpret the statement “I should be saving [or dieting, or exercising] more” to imply that people would be favorably disposed to strategies that offer to help them achieve these goals. In other words, they are open to being nudged. They might even be grateful.

Early experiences with defined-contribution savings plans revealed that Humans could use some help on three fronts: enrolling in the plans, increasing their contribution rates, and improving their investment returns. Nudges have proven to be helpful on all three fronts.