​Forcing workers to save 3 percent won't fix retirement

Behavioral economics have shown that opt-out retirement accounts get more people to save for their golden years than opt-in programs. But what happens if Americans only put in the bare minimum 3 percent of annual earnings?

The answer, according to the nonpartisan Employee Benefit Research Institute, is that America's massive $4.13 trillion retirement shortfall will barely see a dent. If the U.S. introduces an "automatic IRA" program -- as has been proposed by President Obama -- and workers contribute 3 percent of their income, the deficit will only fall 6.5 percent to $3.86 trillion.

While any move to ameliorate America's retirement crisis would be positive, the research suggests that employees need both the opportunity and encouragement to join retirement savings programs, as well as education about how much they'll need when they hit their golden years. Right now, only half of Americans have access to a retirement plan through their employer, with contractors, low-wage and part-time workers and employees at small firms most at risk for lacking such plans.

The automatic IRA, a policy idea developed by the Brookings Institution's Retirement Security Project, would require employers with more than 10 employees and which don't currently offer a retirement plan to automatically enroll their workers in an IRA. While it would require Congressional action at the federal level, the idea was endorsed by Illinois, which earlier this year enacted a new law that will require such automatic IRAs in 2017.

In Illinois, the program will be funded through a 3 percent deduction from workers' paychecks. Although the system isn't mandatory, it works on an opt-out basis, meaning that employees need to take the step to take themselves off the rolls. As observers of human nature know, most people tend toward inertia when faced with paperwork. It's no surprise that opt-out 401(k) programs have participation rates that are as much as 41 percentage points higher than those that are opt-in, according the Center for Retirement Research.

While the automatic IRAs would solve one problem -- getting workers set up with retirement accounts -- it falls short when addressing the other side of the (underfunded) coin: The massive $4.13 trillion retirement savings shortfall that is predicted to leave many seniors in desperate circumstances.

The downside of the default 3 percent minimum contribution level is, once again, human behavior. Such low contribution defaults tend to stick, either because workers fail to take the step to increase the contribution, or they lock people into the mindset that 3 percent is sufficient to create a nest egg.

The solution? Increase the default to a higher retirement savings rate. Australia's national retirement system, called superannuation, recently increased the minimum obligation by employers to 12 percent of workers' paychecks. When the system started in 1992, it only required a 3 percent contribution. No surprise that the Aussie program has been called "retirement done right."

Increasing the default contribution rate for automatic IRAs to 6 percent would only decrease the retirement deficit by 11.9 percent to $3.64 trillion. The answer, it seems, is that automatic IRAs with low default savings rate won't solve the country's retirement problem.