A Positive Theory of Retirement Plan Design

Abstract: We develop a positive theory of retirement plan design using a behavioral contract theory approach. We show that the labor market gives firms strong incentives to offer retirement plans that cater to and exploit workers' biases in order to offer contracts that workers perceive as providing greater total compensation. Employers offer matching contributions when present-biased workers overestimate their future savings. Employers adopt automatic enrollment when the savings-increasing effect on procrastinators is outweighed by the savings-decreasing effect on workers who interpret the defaults as implicit advice. Employers offer investment options with excessive fees when workers naively diversify. Our theory provides novel explanations for a range of facts about retirement plan design and calls into question the practice of depending on employers to design retirement plans to counteract the mistakes of their workers, as many behavioral economists have urged.