Participants must be informed. Law and regulation says so. But beyond the letter of the law, what is the best way to get to the goal of facilitating participants’ financial stability and well-being during retirement? A recent paper argues that financial literacy, and not the length and relative complexity of the information participants receive, is most important.
In “Less Is Not More: Information Presentation Complexity and 401(k) Planning Choices,” a paper prepared for the IZA Institute of Labor Economics, three researchers conclude based on multiple studies that making information presented to participants simpler and more concise is less important than educating them and increasing their financial literacy. The researchers were Eric Cardella and Charlene Kalenkoski of Texas Tech University and Michael Parent of the University of Texas at Austin.
Participants: More Responsibility and Choices
Cardella, Kalenkoski and Parent note that defined contribution plans have become more prevalent than traditional pension plans, and that participants in those DC plans must make choices regarding how much they will contribute to their retirement accounts and how those funds will be invested. This, they argue, can be counterproductive, since it “can be quite challenging for individuals to process the large amount of information provided to them within the short period of time allowed, which might cause them to procrastinate, simply fail to enroll, or make inefficient planning decisions.” Further, they say, participants “often will resort to using ‘rules of thumb’ or rely on the choices or advice of others in making their retirement decisions, and often will stick with default options that are set by the employer, even if it is not optimal for the individual.”
Cardella, Kalenkoski and Parent note that previous research suggested that “A possible avenue through which retirement-planning choices might be impacted is the manner by which information is provided” and that “simplifying the complexity of the enrollment information provided to new employees, which typically is very involved and complex, could impact enrollment decisions.”
Cardella, Kalenkoski and Parent’s hypothesis was that 401(k) participants would make better choices if they were provided with concise information and helpful recommendations rather than long and detailed information.
To test their hypothesis, they performed an experiment with a panel of new employees and a sample of business school students. They provided participants with either a long or short description of a hypothetical employer-sponsored 401(k) plan and asked them whether they would enroll in that plan, and, if they would, what percentage of their salary they would contribute to it. They also asked study participants how they would allocate that salary contribution between bonds and stocks, and they gave them a choice between a pre-assigned default option and a 50/50 stock and bond split.
Cardella, Kalenkoski and Parent report that after accounting for demographics and other factors, the data from their study did not support their hypothesis. They say that they found “no significant differences were found between the control group who received the long version and the treatment group who received the short version in terms of their enrollment rates, contribution rates, and portfolio allocations.” They found those results with both the new hires and the business school students.
“There was essentially no effect of providing simplified information on any planning choices,” Cardella, Kalenkoski and Parent concluded. “Overall, the data do not support the idea that presenting optional 401(k) plan information in a simpler, more compact way will improve employees’ retirement planning choices,” they say.
But they do provide an idea of what employers can do instead. “We did find that financial literacy was positively associated with better choices for both samples,” the researchers write. “This suggests,” they say, “that increasing financial literacy — possibly through educational programs — rather than changing the presentation of plan information would improve decision making regarding 401(k) plans.” They further suggest that default options be designed in a way that improves participants’ financial outcomes, since so many of them avail themselves of the default options.