It only takes a penny.
New research from the Voya Behavioral Finance Institute for Innovation finds that workers struggling to understand retirement plan saving percentages and deferral rates benefit from a simplified approach, one that employs “Pennies-on-the-Dollar” instead.
‘This change significantly impacted savings behavior, especially for lower-income workers …’
For example, a 7% savings rate would be expressed as saving “seven pennies” for every dollar earned.
In a working paper titled “Reducing Savings Gaps Through Pennies Versus Percent Framing,” researchers from Voya, Carnegie Mellon University, Cornell University, and UCLA published results from a field study that involved more than 2,200 working individuals across dozens of organizations.
“It’s a model I’ve used for a long time, and its success is evident in the increase in deferral rates among my clients,” George Fraser, Managing Director of the Fraser Group at RBG who introduced the concept, said. “People don’t understand the language our industry uses, so I see it as appealing to the lowest common denominator. It’s about implementing a more attainable, hopeful approach to retirement.”
Fraser added that one large company with a low-wage employee base achieved a 97.7% participation rate and a savings rate of 9.2 pennies on the dollar after eight years of using the model. When combined with Social Security, it’s a significant sum. Fraser has seen firsthand the change in demeanor from despair to hope in many plan participants when the concept is explained.
The study and working paper
In the study, workers were randomly assigned to two different conditions: A “typical” retirement enrollment screen with savings shown as the percentage of one’s salary, or a “pennies” condition with savings shown as a specific number of pennies for every dollar earned.
This change in information architecture significantly impacted savings behavior, especially for lower-income workers with an average income of $32,000.
SEE THE FULL WORKING PAPER HERE
Specifically, the study found that workers in the percentage condition had an average savings rate of 6.9%, whereas those in the pennies condition had an average savings rate of 8%. To put it in perspective, this savings rate is nearly as high as the savings rate of those participants in the highest income group (a mean salary of $115,000), who saved 8.5% of their salary.
According to Shlomo Benartzi, professor emeritus, UCLA Anderson School of Management, and a senior academic advisor to the Voya Behavioral Finance Institute for Innovation, behavioral economics has taught us that the most powerful tool to improve retirement outcomes for all employees is to periodically re-enroll them with appropriate defaults.
However, Benartzi noted that we also need to expand the behavioral economics toolkit to address situations where auto-features are not feasible.
“In this study, we showed how reframing saving decisions as pennies-per-dollar earned, instead of the typical percent of pay, can have a meaningful impact on future retirement savings,” Benartzi added. “As a result, this behavioral intervention has the potential to boost retirement income by almost 20% if implemented throughout the entire accumulation phase of one’s career. More importantly, it reduces longstanding societal gaps in savings behavior, making it easier for lower-income employees to better prepare for retirement. Over time, helping people save just a few pennies more can add up to thousands of dollars of retirement security.”
Using a ‘pennies’ focus in other areas
While the study’s findings focused on retirement savings, employers have an opportunity to consider the “pennies” framing for other possible savings accounts, such as emergency savings, health savings accounts, and employee benefits.
For instance, an emergency fund could be built through a combination of pennies framing and gradual escalation. Workers could be asked to save one penny out of every dollar earned for emergencies this year, two pennies next year, and so on until they have a viable reserve fund.
SEE CORNELL UNIVERSITY’S STEVE SHU DISCUSS THE FINDINGS AT THE 2022 NAPA 401K SUMMIT
Another approach could make it easier for workers to save a dime for every dollar they earn, automatically allocating those funds to various accounts. For instance, employers could ask a participant to allocate six pennies for retirement, two pennies for emergencies, and two more pennies for health savings.
“At Voya, and through our behavioral finance research, we want to ensure all individuals are allowed to achieve financial security,” Rick Mason, director of the Voya Behavioral Finance Institute for Innovation, and senior research fellow at Carnegie Mellon University, concluded. “We encourage employers and advisors to explore the potential benefits that can come with a deeper understanding of behavioral architecture and the long-term impact it can have to addressing the many savings gaps that exist today.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
