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Common Cents Lab 2018 – Behavioral Science in Retirement Savings

By Josh Leskar

At Human Interest, we are on a mission to enable every small business in America to provide an affordable retirement solution to their employees. Historically, small businesses have had a difficult time offering 401(k)s to their employees, both for financial and administrative reasons. So, we make it possible for any company to offer a customizable, affordable, and friendly 401(k) that is easy for both employers and employees to use.

Setting up a 401(k) is a huge first step, yet one of the hardest parts is encouraging employee participation. Just last year, Richard Thaler won the Nobel Prize in Economics for his work on 401(k) plans, suggesting that the right nudges can lead to increased participation. Specifically, auto-enrollment into a retirement savings account nearly doubled the number of people contributing to their plans, adding an estimated $30 billion dollars into the economy.

While participation rates are extremely higher now as a result, one figure that often slips through the cracks is how much money actually stays in the system. A staggering 40 cents of every dollar invested into 401(k) plans nationwide eventually leaks from the retirement system in the form of hardship withdrawals, loans, and cashouts after termination. Regardless of the circumstance, there is almost always an extremely high penalty on the account balance, resulting in both short term and long term losses. Not only do those who withdraw funds early receive a fraction of their money, they lose out on the opportunity for the original balance to grow exponentially over time.

So, at the Common Cents Lab 2018 Behavior Immersion conference, we set out to learn how we could apply concepts from behavioral science to keep as much of that money in the system as possible in order to fulfill our mission. After all, setting up a retirement account isn’t useful if it ultimately ends up empty. Understanding fully that there are circumstances where there simply are no other options, we sought out ways to encourage participants to keep as much of their money in the system as possible – even if it isn’t ours – because financially they’ll come out far better on the other side.

The first day was filled with lectures on different aspects of finance including saving, budgeting, and spending, in addition to our very own one-on-one with Dan Ariely. Nico Barry, a software engineer here at Human Interest, recalls: “Dan Ariely talked about the pain of paying. With most products, you want to reduce barriers, but sometimes you actually want to increase the difficulty of performing an action in order to achieve a desired result.”

Currently, when someone wants to withdraw funds from their 401(k) account, we only give them two options: take everything, or leave everything. A simple first step would be to offer an additional option to withdraw just a portion of their balance to cover a very specific need. While we offer more options, we can decrease the chance that all of the money is taken out.

Still, this is still not an ideal outcome.

There’s a fine balance to find between constructing too many or unnecessary barriers – especially in the case where someone truly has no other choice but to withdraw – and trying to nudge someone in a specific direction. Behaviorally, there’s a dissonance when it comes to choices we make around finances: every decision is a tradeoff, yet we have a tendency to ignore what we give up in order to gain something. In order to ensure that people are equipped with full information before they make a decision, we can put up thoughtful barriers that ultimately provide context, while not entirely blocking an action people might want to take regardless.

Concretely, it’s extremely easy to ignore the future gains via compound interest in your 401(k) plan in favor of the immediate gratification that comes with a cash influx. So, in order to harness the power of loss aversion, we wanted to make the downside of early withdrawal as explicit as possible so people feel equipped with all the information necessary to make a fully informed decision.

To do this, we thought to highlight the impact in a personalized, visual manner, while simultaneously introducing friction along the way in the form of additional options. Here’s a quick diagram we created at the event as a first version of how we could integrate a user experience that gets at the heart of the issue:

In the absence of an alternative, it’s much easier to simply look at the $4,275 as a net gain. However, taken in the larger context of the entire balance, the pain of giving up nearly $45,000 might hit closer to home. In addition this doesn’t take into account what that money would grow to over time until retirement: another potential win.

The Common Cents Lab also made us think about the entire range of touchpoints that contribute to decision making. This specific idea only reaches people at the final point of withdrawal, but are there ways we could highlight and reinforce the importance of keeping your funds in the system earlier on the process? How can we encourage people to contribute earlier? How can we start using behavioral science to influence our user interface and user experience?

As we continue on our mission to make sure that everyone can live a happy, healthy life in retirement, we’ll keep asking these questions, acting on the answers, and helping people achieve a more secure, financial future as a result.