When Inertia Pays Off

I don’t have to tell you, especially if you’re reading this poolside with a cool drink nearby, that summer is a great time for doing nothing. Turns out Americans—humans, really—are pretty good at that. So behavioral experts have pushed 401(k) plan sponsors to use inertia to our benefit. Make saving effortless, the argument goes, and more people will save. Guess what? It’s working.

Vanguard, the giant investment firm, manages more than $570 billion in 401(k) and equivalent employer-sponsored retirement plans. An analysis of the plans in 2013 found that when enrollment was automatic, 82% of workers participated (employees can opt out if they wish). When employees had to sign up for the plans on their own, only 65% participated.

Automated saving has a downside, however. Vanguard reports that investors who were automatically enrolled in their employer’s savings plan set aside 4.9% of their salary, on average, annually. But those who enrolled on their own shoveled away 7.5%. Fidelity Investments found almost identical averages at the plans in its shop during the first quarter.

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The problem with automatic enrollment is that workers may start out at dangerously low savings rates, and in this case the power of inertia works against them. Fidelity reports that 73% of employers that automatically sweep employees into a savings plan enroll them at a default rate of 3% of salary or less. Even accounting for employer contributions, these workers could be well short of what they should be saving. Of course, they can always set aside more. But many believe their employers endorse the default savings rate, and that can compound their inertia. “Default rates are sticky,” says Jean Young, senior research analyst in Vanguard’s Center for Retirement Research.

Many companies will raise your annual contribution rate for you—again, no need to lift a finger (although you might have to sign up at the beginning). Such plans typically escalate your savings rate by 1% of your salary per year, up to a cap of, say, 6%. About 20% of plan participants at Fidelity increased their savings rate in the past 12 months, and more than one-third of the increases were automatic. Half of the increases young workers made were due to automatic-esca­lation programs.

Upward trend. Still, for many savers (especially those who got a late start or who have no other retirement savings) such nudges might not be enough, says UCLA professor and behavioral finance guru Shlomo Benartzi. It’s generally recommended that savers put away 10% to 15% of their income, including any employer match. “Everyone should look at the default rate and think about whether they should do more,” says Benartzi. “At the same time, employers should be more proactive about suggesting that people go beyond the default.” He sees default rates increasing at corporate plans, for both initial savings and annual increases. “The trend is in the right direction,” he says.

Automating can pay off in areas besides retirement. You can shave 0.25 percentage point off the interest rate on your federal student loans by having your payments electronically debited. Wells Fargo and other private student-loan lenders offer the same 0.25-point rate reduction. And almost all major car insurers will give you a discount for paperless billing or automatic payments. For instance, Allstate’s Easy Pay Plan will discount your premium by 2% to 7% (depending on your state) if you pay via automatic withdrawals from your bank account. Auto-pay six months’ worth of premiums at a time and you’ll save 5% to 13%.

So go ahead, relax. As long as you set the right course, parts of your financial life will do fine on autopilot.

Anne Kates Smith is a senior editor at Kiplinger’s Personal Finance magazine.