Trust a Critical Factor in 401(k) Participation

Although behavioral components are important, financial literacy and trust are critical variables in understanding 401(k) plan savings behavior.
According to a new paper from the Center for Retirement Research at Boston College, financial literacy and trust have more sizeable marginal effects on 401(k) savings behavior in voluntary and automatic enrollment 401(k) plans than income.
Paper authors Julie R. Agnew, Lisa Szykman, Stephen P. Utkus, and Jean A. Young found that both factors play a significant role in savings decisions. Financial literacy reduces both the proportion of non-joiners in voluntary 401(k) plans and the proportion of quitters in automatic enrollment plans. Trust also improves quit rates in automatic enrollment plans, the paper said.
As a result of the trend towards automatic enrollment plan design, there are now two types of non-participants, the authors explain: “non-joiners,’ those who fail to join voluntary 401(k) arrangements; and “quitters,’ those who exercise their opt-out rights under an automatic enrollment plan. The automatic enrollment trend leads the authors to ask another question about retirement plan participants: “Are quitters (of automatic enrollment plans) fundamentally different from non-joiners (of voluntary plans)?’
The paper examined the role that trust plays in influencing quit rates in automatic enrollment plans. In order to gauge the trust of the employees, the authors asked a specific trust question. The question was, “for the most part, financial institutions are trustworthy,’ to which respondents were to answer one of the following: strongly disagree, disagree, neither, agree, or strongly agree.
Of those answering the question, the category that had the highest percentage of individuals with low trust (42%) is high school. Further, nearly half of the automatically enrolled non-participants have low trust, a much higher percentage than participants in either type of plan and non-participants in voluntary plans, the paper noted.
When it comes to automatic enrollment plans, trust seems to be important in influencing savings behavior, because individuals are more likely to opt out if they do not have a fundamental trust of financial institutions. It seems that low trust can be associated more with lower educated individuals, the authors wrote. If employers are looking to improve high quit rates in automatic enrollment plans, they “may wish to consider efforts not only to improve financial literacy but to reduce employee mistrust of financial institutions, particularly among the lowest paid.’
Financial Literacy
In examining financial literacy, the authors said that higher financial literacy among workers is associated with higher voluntary 401(k) participation rates or lower quit-rates in automatic enrollment plans. “The marginal effects of low financial literacy appear to be economically more meaningful than the effects of higher income.’
Study participants were asked three basic financial knowledge questions:
  • If you are saving for a future goal, it’s better to start early. That way your money earns more and builds up faster over time. (Answer choices: True or False)
  • If you were to invest $1,000 in a stock mutual fund, it would be possible to have less than $1,000 when you withdraw your money. (Answer choices: True or False)
  • In which ONE of the following products would you choose to invest your money for the highest expected long term growth? (Answer Choices: Stock Mutual Fund, Savings Account, CD, Insurance Policy, Don’t Know/Refused)
Study participants were asked whether their company currently offered a retirement plan, and if they answered yes, they were asked three more questions:
  • Do you currently contribute part of your paycheck to your company’s retirement savings plan? (Answer choices: Yes or No)
  • Some employers offer a matching contribution in their retirement savings plan. With a matching contribution if you put in your money, the employer also adds some money to your account. Does your plan offer matching contributions? (Answer choices: Yes or No)
  • Are your participants allowed to take loans from your retirement savings account? (Answer choices: Yes or No)
Although all of the voluntary enrollment participants knew they were participating and 99% of the automatically enrolled participants knew, non-participants in both types of plans often thought they were participating when they were not. Most puzzling, the researchers said, was the 23% of the non-participants in the automatic enrollment plan who were participating, especially since they must have actively opted to not participate.
The authors said their research underscores the importance of ongoing workplace education for both voluntary and automatic enrollment plans. “Our results support both a rational information gap theory — that some participants are impeded by a lack of adequate financial information — and a behavioral bias theory — that others may be influenced by the psychological level of trust they have in institutions,’ the authors wrote.