Paying Not to Get the Match: a Behavioral Contract Theory of Retirement Plan Design

Abstract: The primary motivation for retirement savings policy is the view that many of us, if left to our own devices, will not save enough for retirement. Special tax subsidies for employer-sponsored retirement plans—a principal component of the federal policy scheme—have made such plans the predominant vehicle for private savings for retirement. A large body of evidence shows that the details of plan design can have large effects on savings outcomes. The design of the “choice architecture” of these plans, however, is delegated to employers. We analyze the incentives for employer plan design produced by the labor market. Employers offer retirement plans to attract workers. If those workers make systematic mistakes in their retirement savings decisions, then the labor market will produce incentives for plan designs that generally fail to effectively address the problems. Indeed, the presence of workers who undersave due to myopia results in equilibrium employer plan designs that exploit the myopic by lowering their total compensation. Our analytic framework provides novel explanations for a range of features of plan design, including the high prevalence of matching contributions, the use of low default contribution rates in automatic enrollment plans, the shift away from annuities toward lump sum distributions, and the offering of investment options with excessive fees. The regulation of these plans should be reformed to address the problems with employer incentives that we identify. More fundamentally, our analysis calls for a rethinking of the current scheme’s special subsidies for employer-sponsored plans.