New paper: “The Welfare Economics of Default Options in 401(k) Plans”

From the American Economic Review: The Welfare Economics of Default Options in 401(k) Plans

B. Douglas Bernheim, Andrey Fradkin and Igor Popov

Default contribution rates for 401(k) pension plans powerfully influence choices. Potential causes include opt-out costs, procrastination, inattention, and psychological anchoring. Using realistically parameterized models, 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. While results are theory-specific, 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. (JEL D14, D91, J26, J32)

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