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If transaction costs are small, standard economic theory would suggest that defaults have little impact on economic outcomes. Agents with well-defined preferences will opt out of any default that does not maximize their utility, regardless of the nature of the default. In practice, however, defaults can have sizable effects on economic outcomes. This chapter summarizes the empirical evidence on defaults in savings outcomes, which strongly suggests that defaults affect savings outcomes at every step along the way. The different types of US retirement income institutions and some of their salient characteristics are described. Empirical evidence from the USA and other countries, including Chile, Mexico, and Sweden is presented on how defaults influence retirement savings outcomes at all stages of the savings life cycle, including savings plan participation, savings rates, asset allocation, and post-retirement savings distributions. The chapter then examines why defaults have such a tremendous impact on savings outcomes. Finally, it considers the role of public policy toward retirement saving when defaults matter.

The chapter examines how workers’ attitudes about money and retirement planning influence their participation in defined contribution (DC) pension plans. Workers were grouped into five “money attitude” clusters. Individuals showed difference preferences for the types of planning activities needed to be successful in conventional DC plans.

Governments around the world spend hundreds of billions of dollars subsidizing retirement savings through various tax preferences. This chapter reviews the economics literature on retirement savings, with a particular focus on recent advances using behavioral economics and high-quality administrative data. This literature suggests that existing tax subsidies may not be an effective policy to increase retirement savings for three reasons. First, tax subsidies appear to primarily affect the allocation of savings across accounts, rather than the total amount of savings. Second, many savers are inattentive to tax policy when choosing the level of savings. Third, those savers most sensitive to tax subsidies are not those with the greatest savings inadequacy. These same forces suggest that alternative policies focusing on behavioral “nudges,” such as automatic enrollment and access to payroll-deduction accounts, may be more effective.

This chapter examines the factors influencing enrolment in 401(k) retirement plans. In one study, a random sample of employees was asked to attend a benefits information fair organised by the employer. It was found that employees’ decisions to participate in the plan were influenced by their peers rather than the information provided by the fair.

This chapter explores the role of mutual funds in U.S. households’ retirement and education savings. Nearly three-quarters of mutual fund-owning households in mid-2013 showed that saving for retirement is their household’s primary financial goal. With the rise in individual account-based retirement savings, mutual funds’ role in U.S. households’ retirement planning has risen over the past few decades. At year-end 2013, U.S. investors had $23.3 trillion earmarked for retirement, with more than half held in individual account-based retirement savings with about half of those accounts invested in mutual funds, mainly in equity funds. One-quarter of mutual fund-owning households reported that saving for education is one of their household’s financial goals. Specifically earmarked education savings totaled more than $234 billion at year-end 2013, mainly in 529 savings plans, which invest in mutual funds.

This chapter outlines ways of building a bigger and better retirement income system in the United States. It first traces the evolution of today's retirement programs, focusing on Social Security and defined contribution plans. It then discusses the challenges involved in making decisions concerning retirement savings, as well as the impact of the financial crisis on retirement plans. The chapter also assesses the impact of recent public policies aimed at reforming the existing retirement income system and considers a new tier of individual retirement saving accounts that would replace approximately 20 percent of a worker's pre-retirement income. Finally, it compares this tier with Social Security and concludes that the latter is a better option in which to invest equities.

Labor income is an asset, and for young investors the value of labor income usually dominates the rest of their financial holdings. An investor’s mix of assets changes as her labor income evolves over her life cycle, and an investor whose labor income is bond-like should reduce his holdings of equities as retirement approaches. While economic theory suggests that annuities are ideal for retirees, few hold them.

This chapter analyzes how low- and moderate-income retirees utilize retirement savings, and how financially fragile they are, relying on survey data on public employees in North Carolina. We investigate whether retirees make systematic errors when they manage their assets so as to maintain their standards of living, and whether there are notable differences in financial management skills across subgroups. We also ask whether financial literacy is positively associated with lower rates of committing such errors and, and whether low-income households have lower levels of financial literacy leaving them likely to make poor financial decisions. We show that many retirees have no emergency cash, and one quarter maintain high-interest debt while leaving low-return funds in retirement saving plans. Suboptimal debt holding is associated with lower household income and lower financial literacy.

This chapter examines concerns about what workers do with their participant-directed retirement savings plans. While recent restructuring has made defined contribution plans considerably more effective savings vehicles, what people do with these portable accounts when they switch jobs or retire is not clear given that many workers have trouble making sound financial decisions. The chapter presents data showing the disposition of employer-sponsored retirement benefits at termination of employment between 1992 and 2004. It considers the increase in the number of retirees who discarded retirement annuities in favor of managing their retirement accumulations on their own. It also discusses proposals to automatically annuitize retirement savings and the residual risks that remain even if annuitization at retirement becomes automatic. The chapter suggests that there are no magic solutions to retirement security dilemmas.

This chapter explores the specific causes and size of America’s worsening retirement problem. It first sets out a goal for households: to save enough to maintain their pre-retirement standard of living when they retire. It then assesses how demographic and economic changes have made meeting this savings goal more challenging. The chapter next lays out how traditional sources of retirement income—Social Security and employer-sponsored retirement plans—are providing less support. It concludes by quantifying the overall magnitude of the retirement income challenge.

This chapter discusses steps that individuals can take to improve their retirement prospects, namely working longer and saving more. Working longer increases monthly Social Security benefits, allows more time to accumulate savings, and shortens the length of retirement. To work longer, individuals should maintain technical skills, communicate their plans clearly to their employer, and take steps to stay in good health. Saving more requires individuals to navigate many competing pressures for their income. A good way to save more for those with a 401(k) plan is to sign up promptly, contribute at least enough to receive the full employer match (and more if possible), invest in low-cost mutual funds, keep the money in the plan until retirement, and draw down the accumulated assets effectively at retirement. Additionally, the home can be an important retirement asset, which can be tapped through downsizing or a reverse mortgage.

This chapter presents evidence on the distribution of balances in 401(k)-type retirement saving accounts under various asset allocation strategies that investors might choose. In addition to a range of age-invariant strategies, such as an all-bond and an all-stock strategy, it considers several different life-cycle funds that automatically alter the investor's mix of assets as he or she ages; and a no lose allocation strategy, in which households purchase enough riskless bonds at each age to ensure that they will have no less than their nominal contribution when they reach retirement age, and then invest the balance in corporate stock. The results suggest several conclusions about the effect of investment strategy on retirement wealth. First, the distribution of retirement wealth associated with typical life-cycle investment strategies is similar to that from age-invariant asset allocation strategies that set the equity share of the portfolio equal to the average equity share in the lifecycle strategies. Second, the expected utility associated with different 401(k) asset allocation strategies, and the ranking of these strategies, is very sensitive to three parameters: the expected return on corporate stock, the relative risk aversion of the investing household, and the amount of non-401(k) wealth that the household will have available at retirement.

This chapter argues that the U.S. retirement system that has served generations retiring in the past is no longer sustainable in many cases for the baby boom and future generations. It first considers issues surrounding employer-sponsored pension plans and the implications of the shift from defined benefit plans to defined contribution plans. It then discusses tax preferences for employer-sponsored retirement plans, including health benefit plans, and the principles behind pension insurance. It also looks at the excise tax on surplus funds removed from a pension, public pensions, the dilemma concerning defined contribution annuities, and the challenges involved in encouraging workers to opt for annuitization of their retirement savings.

A major concern in the debate about replacing the current social security system in the United States with a system of self-directed personal investment accounts is that ordinary Americans will not be able to cope with the complexities of providing for an adequate income in retirement by investing on their own. This chapter shows how government and private-sector financial institutions can offer people a menu of investment choices that are at least as good as the ones they have now. It first examines the economic theory of optimal lifetime consumption and portfolio selection to see what guidance it offers for the investment of retirement savings. It then demonstrates how to use financial engineering to produce a menu of investment choices defined by a guaranteed minimum level of benefits plus participation in a reference portfolio of stocks. It also considers the role of the government in implementing a system of private investment accounts. Finally, it looks at some of the investment advice offered by investment management firms.

The eighteen-year bull market of 1982-2000, combined with new fund products and distribution systems and legislation providing incentives for individual retirement savings, propelled mutual funds into becoming the largest financial industry in the world, surpassing U.S. banking institutions. These developments led to proposals to subject mutual funds to bank-type regulation and to move from direct regulation of mutual funds by the SEC to self-regulation by the industry itself. Fortunately for both fund shareholders and the industry, neither type of proposal was adopted.

In a previous study, the authors of this chapter evaluated the extent to which the different wealth accumulation of households with similar lifetime earnings could be accounted for by random shocks, such as health status and inheritances, that could reduce or increase the available resources out of which saving could be drawn. They concluded that only a small fraction of the dispersion in wealth accumulation within lifetime earnings deciles could be accounted for by random shocks, and thus that most of the dispersion could be attributed to choice; some people save while young, others do not. This chapter continues that analysis but with two additions: first, it evaluates the effect of investment choice on the accumulation of assets — in particular, how much of the dispersion in wealth can be accounted for by the choice between investment in the stock market and investment in presumably less risky assets such as bonds or bank saving accounts. Second, it attempts to understand the relationship between asset accumulation and individuals' assessment, just prior to retirement, of the adequacy of their saving and their saving behavior. The results indicate that the bulk of the dispersion in wealth at retirement results from the choice of some families to save while other similarly situated families choose to spend. For the most part, controlling for lifetime earnings, persons with little saving on the eve of retirement have simply chosen to save less and spend more over their lifetimes. Families with modest lifetime earnings would have accumulated substantial wealth had they saved consistently and invested prudently over the course of their working lives.

This chapter draws together previous research on withdrawals from retirement saving plans to gauge the importance of such withdrawals on the saving balances of future retirees. The chapter is organized as follows. Section 1.1 summarizes the recent studies that have explored the importance of lump-sum distributions from 401(k) plans and other retirement saving plans. Section 1.2 describes the algorithm for projecting the 401(k) balances of future cohorts of retirees, and particularly researchers' attempts to allow for preretirement asset withdrawals. Section 1.3 presents evidence on how actual 401(k) balances for households in the Health and Retirement Survey compare with the balances that the algorithm would have predicted for these households, if actual plan balance was unknown. Section 1.4 reports projected future account balances and examines the importance of preretirement withdrawals in affecting these balances. Section 1.5 reports preliminary statistics on 401(k) participation from the 1995 Survey of Income and Program Participation, and uses these data to provide some indication of the plausibility of the projected rates of 401(k) expansion. Finally, a brief concluding section suggests several directions for further work. A commentary is also included at the end of the chapter.

This chapter evaluates the effect of holding a broadly diversified portfolio of common stocks compared to a portfolio of index bonds on the distribution of 401(k) account balances at retirement using stochastic algorithm. It describes the distribution of wealth outcomes for different investment allocation rules and calculates an expected utility measure corresponding to each distribution. This chapter concludes that both approaches to the evaluation of risk can be important and that the appropriateness of each is likely to depend on the specific goal of the evaluation.

This chapter proposes a theory of optimal defaults in related to retirement savings. It suggests that it is sometimes optimal to set extreme defaults that are far away from the mean optimal savings rate. This chapter discusses the application of the proposed model to calculate optimal defaults for employees at four different companies. The findings reveal that optimal defaults are likely to be at one of three savings rates: 5 to 6 percent of the employer match threshold or about 15 percent of the maximal savings rate.