Defaults Play a Big Role in Savings Outcomes

According to “Do Defaults Have Spillover Effects? The Effect of the Default Asset on Retirement Plan Contributions,” a research paper published by the National Bureau for Economic Research (NBER), when the Federal Thrift Savings Plan (TSP) switched to a lifecycle fund for a government securities fund as the default investment for participants who did not actively make a choice, participants were saving less.

The sample consists of employees employed at the Office of Personnel Management (OPM) both before and after the change in the default asset allocation. The researchers contend that the lifecycle fund may be considered a more appropriate default in that the allocation is likely preferable to a higher percentage of employees as compared to the conservative fund which may not be well-suited for long-term wealth accumulation.

The findings suggest that employees approach asset and deferral decisions jointly. They found those who were defaulted into the lifecycle fund remained passive and did not increase their deferral rates to maximize the employer match. “This joint decision-making combined with a better-suited default fund may partly explain why employees fail to maximize their employer matching contributions,” according to the white paper.

The paper warns that changing to a default fund that is preferred by more employees may lead people to be less well-prepared for retirement.

“This paper contributes to the growing literature on the unintended consequences of defaults,” the paper says. The researchers point to a previous study which found, while automatic enrollment dramatically increases participation in defined contribution (DC) plans, it comes at the cost of higher persistence by employees at the default contribution rate, which are often set at a rate that does not maximize the match from the employer and may not maintain an adequate level of consumption into retirement. Another study found that the introduction of a lifecycle fund as the default has led some employees to hold portfolios that mix the lifecycle fund with other assets, though lifecycle funds are intended to be standalone portfolios.