401(k) Contributions in Pennies, Not Percentages

The retirement savings gap between lower income and higher income earners is well known. Providing retirement and investment education to employees has shown to raise contribution levels among lower paid workers, but it’s not enough.

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    401(k) Contributions in Pennies, Not Percentages

    401(k) Contributions in Pennies, Not Percentages

    The retirement savings gap between lower income and higher income earners is well known. Providing 401(k) retirement and investment education to employees has shown to raise contribution levels among lower paid workers, but it’s not enough.

    According to a recent paper, further progress in narrowing that gap may be as simple as reframing the contribution rate decision by replacing the conventional “percentage of pay” framing with a less abstract “pennies per dollar earned” (e.g., 7 cents for every dollar of pay).1

    Of course, there is no difference from a mathematical perspective. However, to the less numerate or less financially literate employees, the framing of contributions in pennies per dollar earned is far more understandable. This improved understanding can result in greater participation and higher contribution rates.

    One part of this research was conducted with actual participants of plans serviced by Voya Financial. Their findings indicated that the pennies framing led to higher intended savings rates. The paper’s authors then recruited plan sponsors and worked with Voya to provide a mix of enrollment screens to test the effect of the two contribution-rate framing options.

    What they found was that there was a statistically significant difference in the amount lower income employees elected to contribute under the pennies framing. In the lower third of income earners in this study, the contribution rate under the pennies framing was nearly 17% higher than the percentage framing (8.03% versus 6.88%). As expected, this differential narrowed as income levels rose until the difference between the two framing options become statistically nil at the highest earning tercile employee group.

    What Advisors Can Do

    Advisors may want to consider how they can amend their 401(k) presentations to include the framing of 401(k) contributions in terms of pennies per $1 of pay, especially to the lower earning employee groups.

    The other important step they can take is to work with plan sponsors and plan providers to discuss ways to change the contribution election section of the enrollment process to include a pennies framing option (e.g., “I would like to contribute ____ pennies for every $1 I earn”).

    While it may appear daunting to get employers or plan providers to change an ingrained practice of percentage framing, the alignment of plan sponsor, advisor and plan provider to improve retirement outcomes for workers and grow plan assets should make the case for pennies framing a hurdle worth overcoming.

    Sources:

    1. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4042843

    Please reference disclosures: https://blog.americanportfolios.com/disclosures/

     

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