Wharton Profs: Make Retirement Planning Simpler

Shocker: 401(k) plans are too complicated.



There’s a scene in the old Robin Williams movie, Moscow on the Hudson, in which Williams’ character — a newly minted Russian immigrant, freshly defected from Communism — goes grocery shopping for the first time. On his list: Buy coffee. Sounds like a simple task, right?

Not for Williams’ character. When he arrives in the coffee aisle, the poor man is overwhelmed by the endless array of brands he has to choose from. “Coffee, coffee, COFFEE!” he shrieks, collapsing in a panic attack.

According to research by a pair of Wharton professors, Donald B. Keim and Olivia S. Mitchell, that experience may not be all that different from choosing a 401(k) retirement plan.

“Too many choices may create confusion, resulting in poorly informed consumer decisions,” says the new report, published by the National Bureau of Economic Research.

The duo studied an American non-profit organization that in 2013 streamlined its 401(k) options — eliminating more than 39 choices from a menu of nearly 90. The eliminated funds were often similar to choices that remained on the menu. Before the change, “there may have been six or seven choices in the same asset class, so there was a lot of redundancy of choice,” Keim told the Wall Street Journal.

“Cognizant of the growing literature on choice overload, the firm’s investment committee in 2011 determined that a simpler, easier-to-understand tiering of the funds on offer would be easier to administer, explain, and rationalize compared to the prior menu,” Keim and Mitchell wrote in their report.

Employees who held the eliminated options had to move their money into a new fund. The result? Those employees chose expose themselves to lower fees and lower risk, saving them an estimated average of $9,400 over a 20-year period.

Keim and Mitchell suggest that too many retirement fund options make it difficult for workers to make the best decisions for themselves.

“With information overload, people tend to just pick something quickly and get it over with,” Mitchell told Time magazine.

How to fix this issue? Two possibilities:

  • Companies may need to take a more “paternalistic” approach in guiding worker retirement choices. In fact, that’s been the trend in recent years, one expert says. “In the last five years, people have been coming down on the paternalism side,” Rebalance IRA’s Jay Vivian told the WSJ. “Paternalistic may be too strong a word, but now plan structures are made to point people in the direction of making better decisions.”
  • Employees can get smarter about the choices they’re making — or at least simplify the process with an easy rule of thumb or two. “If you’re confused by the funds offered in your company’s 401(k) plan, Mitchell advises that you start by looking at funds with the lowest fees,” Time reports. “And less knowledgeable employees should consider target-date funds, which allocate your retirement savings based on your age and projected retirement date.”

The duo’s report suggests companies might consider the former approach carefully. “Employers in their plan fiduciary capacity are charged under pension law with managing retirement plans in the best interests of participants,” they write. “Our work implies that plan sponsors would do well to recognize that the length and complexity of the plan menu matters.”

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