Automatic Enrollment and Optimal Defaults in a Second Best Environment: Evidence from Auto-IRAs

• In Event: Saving for Retirement

Abstract

How does automatic enrollment affect savings accumulation? What is the optimal default option for automatic enrollment policies? Using linked employee-employer data from early adopting states, I answer these questions by examining the effects of automatic enrollment in state auto-IRA programs, finding large, persistent increases in retirement saving, with participants retaining their savings even after job separation. Leveraging the automatic escalation feature of auto-IRAs, I show that auto-IRA participants facing higher default rates are more likely to opt out of default rate saving and into a zero saving rate. To rationalize these patterns, I extend standard models by incorporating frictions for deviating from both non-saving and default saving. I structurally estimate annual frictions of 0.22% of income for default saving and 0.24% for non-saving. I then calculate the optimal default rate under various assumptions on whether these frictions reflect real costs or behavioral biases, finding this optimal rate to be between 2.9% and 3.8% under each assumption. In most parameterizations, the results rule out default policies that promote active choice as optimal. The findings recommend setting broadly attractive default rates, even if default effects reflect behavioral biases; in this case, the default rate acts as a second best option that mitigates other distortions to saving behavior.

Author

• Thomas Willingham, University of Virginia; Joint Committee on Taxation