The Welfare Economics of Default Options in 401(K) Plans

54 Pages Posted: 15 Nov 2011

See all articles by B. Douglas Bernheim

B. Douglas Bernheim

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Andrey Fradkin

Boston University - Questrom School of Business

Igor Popov

University of Southampton

Date Written: November 2011

Abstract

Default contribution rates for 401(k) pension plans powerfully influence workers’ choices. Potential causes include opt-out costs, procrastination, inattention, and psychological anchoring. We examine the welfare implications of defaults under each of these theories. We show how the optimal default, the magnitude of the welfare effects, and the degree of normative ambiguity depend on the behavioral model, the scope of the choice domain deemed welfare-relevant, the use of penalties for passive choice, and other 401(k) plan features. Depending on which theory and welfare perspective one adopts, virtually any default contribution rate may be optimal. Still, our analysis provides reasonably robust justifications for setting the default either at the highest contribution rate matched by the employer or – contrary to common wisdom – at zero. We also identify the types of empirical evidence needed to determine which case is applicable.

Suggested Citation

Bernheim, B. Douglas and Fradkin, Andrey and Popov, Igor, The Welfare Economics of Default Options in 401(K) Plans (November 2011). NBER Working Paper No. w17587. Available at SSRN: https://ssrn.com/abstract=1960134

B. Douglas Bernheim (Contact Author)

Stanford University - Department of Economics ( email )

Landau Economics Building
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650-725-8732 (Phone)
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National Bureau of Economic Research (NBER)

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Andrey Fradkin

Boston University - Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States

HOME PAGE: http://www.andreyfradkin.com

Igor Popov

University of Southampton ( email )

University Rd.
Southampton SO17 1BJ, Hampshire SO17 1LP
United Kingdom

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