Smoothing the Rocky Road to Retirement

Although Ben Franklin is credited with the adage “A penny saved is a penny earned,” he unfortunately didn’t clarify how to save that penny. Should we contribute to a 401(k)? Which type? Before or after taxes? And how can employers help?

In his defense, 401(k) plans and auto-enrollment policies didn’t exist when Franklin first penned the concept in the 1737 edition of Poor Richard’s Almanack [sic] (he actually wrote, “A penny saved is two pence clear”) or when he revisited it some 20 years later (“A penny saved is a penny got”). And even if those savings tools had existed then, there’s a good chance the Founding Father wouldn’t have been able to explain exactly how to use them.

That’s because when it comes to saving for retirement, deciding which savings tool to use and how to contribute almost requires a comprehensive understanding of the US tax code. This is fitting because both the 401(k)—the most common retirement savings tool available—and its older sibling, the 403(b), both get their names from the sections of the tax code that defined them.

Fortunately, BYU Marriott is home to one of the nation’s foremost behavioral economists who is an expert on retirement savings plans: Dean Brigitte Madrian. Her work in the area of household saving and investment behavior has impacted the design of employer-sponsored savings plans and has influenced pension reform legislation in the US and abroad.

“I have learned in my years of analyzing household financial decision-making that even when stakes are high, many people don’t know how to make good financial decisions,” Madrian says.

While Madrian and her colleagues can’t provide a universal road map for every future retiree, her research and expertise can guide workers—whether early career, mid-career, or nearly ready to retire—as they embark on critical financial decisions. Madrian’s research can also help decode the strategies that companies use to help people save and the steps smart workers take to maximize those programs.

Navigating Unfamiliar Territory

When Grace Pope graduated from BYU in April 2024, sorting through retirement plans wasn’t top of mind. Like everyone else in her cohort, she celebrated her new degree and wrestled with the normal anxiety of joining the workforce.

“I know that saving for retirement starting day one of your career is ideal and offers the biggest long-term impact, but it’s hard because I don’t know how to compare the options,” Pope says. “On top of that, I don’t have the luxury of comparing retirement benefits when just getting a job is my priority.”

Pope is not alone. A survey from the Transamerica Center for Retirement Studies finds that an average of 60 percent of college graduates say they do not know as much as they should about retirement planning. (That number is closer to 80 percent for those with a high school diploma or less.) The same survey also reports that nearly 40 percent of college grads prefer not to think about or concern themselves with such planning until closer to retirement.¹

Although Pope took a family financial planning class on campus during her senior year, she admits that when it comes to retirement planning, “I just don’t know where to start.” For those midway through their careers, the sentiment may be more along the lines of “Where do I go from here?” And those nearing retirement may be wondering “How do I protect my retirement savings?”

Regardless of one’s current location on the road to retirement, the research and perspective of Madrian and her colleagues is filled with helpful insights.

Madrian’s expertise in the field stems from decades of work: she earned her PhD in economics from MIT in 1993 and then made teaching stops at the Harvard University Economics Department, the University of Chicago Graduate School of Business, and the University of Pennsylvania Wharton School. From 2006 to 2018, Madrian was the Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School. At every destination she has published regularly with Harvard colleagues John Beshears and David Laibson as well as Yale’s James Choi, among others.

“We’ve found that society makes it really easy for people to make poor decisions, because making good decisions is often time-consuming and complicated,” Madrian says. But there’s also good news: “A lot of our research finds there are clear ways that companies can make it a lot easier for employees to make good financial decisions when it comes to retirement savings.”

Planning Your Route

The first—and arguably the most effortless—savings tool provided by employers is a pension, specifically a defined benefit plan. This traditional pension dictates that employers pay retirees a specific amount (either a lump sum or a monthly disbursement) based on the employee’s earning history, years of service, and age. The wisdom is simple here: if your company still offers a traditional pension, you’re lucky to have it. (Of course, whether or not companies will be able to actually pay that full pension in the future is another conversation.²)

But defined benefit pensions are rare these days. Less than 15 percent of private US companies still offer them,³ and this is why Madrian’s research is so important. Unlike pensions, which don’t require employees to take action, the savings tools used most today—the 401(k) or its nonprofit/government employee counterpart the 403(b)—depend on employee contributions. This shift means that more than ever, workers need to understand these savings tools if they want to be ready for retirement.

The 401(k) allows employees and their employer to put a percentage of each paycheck into a savings account, and that money is invested to grow the account’s balance. Workers then choose how to invest the money by selecting from a buffet of employer-provided and managed options. The technical term for choosing how to invest 401(k) funds is asset allocation (see the end of this article).

There are two types of 401(k)s: a traditional 401(k) and a Roth 401(k). The difference between these two 401(k)s boils down to timing and taxes. Traditional 401(k)s give employees a tax break up front, but down the road, they require that retirees pay taxes on both the principal and investment earnings when they withdraw from the fund. With a Roth 401(k), employees pay the taxes up front and don’t have to pay taxes on that money ever again.

Employees new (like Pope) and seasoned have long wondered which route—before-tax or after-tax—is the most advantageous. Madrian acknowledges it is a tricky decision to make.

“The federal government is going to try to get their taxes either when you’re earning the money or when you’re taking the money out of the plan at retirement,” Madrian says. “The general rule of thumb is if you think your tax rate is going to go up over time, then you’d rather pay the taxes today; if you think it will go down over time, then you’d rather pay the taxes in the future.”

How can you know if your tax rate will increase or decrease? Madrian says there are no hard-and-fast rules, but if you’re a recent college grad and you’re in your first job, chances are your income is going to accelerate over time. In that case, the Roth option probably makes more sense. If you’re at the peak of your career with a high income and your tax rate is likely to go down when you retire, it might make more sense to contribute on a before-tax basis.

Madrian points out two other considerations: First, many financial experts assume that at some point the federal government is going to have to raise tax rates, which may be another reason to consider paying your taxes up front.

Second, most companies now allow employees to contribute to both a traditional 401(k) and a Roth 401(k). This approach allows an employee to hedge their bets on whether tax rates are going to go up or down. The Plan Sponsor Council of America reports that 88 percent of 401(k) plans offered a Roth option in 2021, up from 49 percent a decade earlier.⁴

Contribution Crossroads

Unfortunately for Ty and Shelby Clark, they don’t currently have access to either 401(k) option. Shelby Clark graduated from BYU in summer 2024 and is finishing an internship; Ty Clark is working full-time, but his small-company employer doesn’t sponsor a retirement plan. So the couple is saving for retirement in a Roth IRA—a personal savings account that operates similarly to a Roth 401(k). The Clarks, however, are the only party putting money in every month. It’s a big reason why they are currently job hunting.

Employer contributions are a major benefit to employer-sponsored retirement savings plans. These employer contributions typically come as a match—up to as much as a dollar for every dollar an employee saves and commonly maxing out around 5 to 6 percent of an employee’s compensation. According to Fidelity Investments, one of the most common matching formulas is a 100 percent dollar-for-dollar match on the first 3 percent of an employee’s contribution and a 50 percent match on the next 2 percent. In this scenario, if an employee contributes 5 percent of his or her monthly salary/wages to a 401(k), then the employer chips in another 4 percent, with the monthly contribution being 9 percent of that employee’s salary.

Data from a 2023 Vanguard study shows that roughly half of companies offer between a 4 and 6 percent 401(k) employer match, with 4.5 percent being the average match.⁵ A match above 6 percent is less common but obviously more generous. No matter what a company offers, it’s wise to take full advantage of the match, Madrian says.

“If you can afford it, try to put in at least the full amount you can give to get the full company match,” she continues. “But that doesn’t mean you should stop there.”

There is a very natural tendency for employees to think, “I’m good with putting away 10 percent,” Madrian explains. But that may not be enough. Social Security won’t replace a high income, so higher-income employees will need to save a higher fraction of their pay. Likewise, employees who wait until their 40s to start saving will need to save at a much higher rate than employees who started in their 20s.

Regardless, maximizing an employer match should be a no-brainer for employees. And if the goal is to increase savings in general, the research shows that providing a match should also be a no-brainer for employers, institutions, and policymakers. But by far the most effective method to increase participation in retirement savings tools like the 401(k) is something that has been at the heart of Madrian’s research for more than two decades: automatic enrollment.

Shifting into Automatic Enrollment

Automatically enrolling employees in 401(k) plans has been around since 1984 when McDonald’s became the first company to implement the practice. The intention of auto-enrollment is to get more people to save for retirement by eliminating decision-making on their part; the employer automatically deducts a set percentage of an employee’s wages, the employer picks out a reasonable investment allocation, and the employer handles all of the paperwork.

But making enrollment the default option for new employees didn’t pick up steam until Madrian published a seminal paper on the topic in 2001. In what was then the first study ever to measure the impact of automatic enrollment on savings outcomes, Madrian and coauthor Dennis Shea documented a staggering 50 percentage point increase in 401(k) participation among newly hired employees at one large US company that started to implement the practice. The study also revealed that automatic enrollment is successful at increasing 401(k) uptake among employees least likely to participate in retirement savings: lower-paid, young, and Black or Hispanic employees.⁶

These findings changed the conventional wisdom on employer-provided retirement tools and set Madrian on a two-decades-long research journey detailing the impact of auto-enrollment and advocating for broader implementation.

“The evidence is strong, consistent, and dramatic: automatic enrollment is very effective at getting people into a retirement savings plan,” Madrian says. “Most employees are happy with it because they don’t have to do anything, and they’re saving for retirement.”

Madrian’s research has not only been a paradigm shifter, but it has also led directly and indirectly to millions of more Americans saving for retirement. Federal and state legislation heavily influenced by the work of Madrian and her peers, such as the Pension Protection Act of 2006, has made it easier for companies to automatically enroll employees into 401(k)s and has significantly spurred adoption of the practice.

Roughly two-thirds of private companies in the United States now use automatic enrollment,⁷ and countries including the United Kingdom, New Zealand, and Turkey also now have national pension regulations that require automatic enrollment.

“It has been incredibly rewarding to conduct academic research that has had an impact on legislation at the state, national, and international level that helps improve retirement savings outcomes for individuals,” Madrian says. “I didn’t set out to do that; I just wanted to make a difference. I feel fortunate to have been part of a journey of intellectual discovery that has also had a positive impact on people’s lives.”

Despite her current heavy administrative load as dean, Madrian continues to collaborate with other researchers; they recently published an article that served as an extension of the original blockbuster on auto-enrollment. They began wondering: If people are saving more money through mechanisms like auto-enrollment, then where is that money coming from? Are they consuming less or simply moving existing savings around? Or are they turning to credit cards because their take-home pay is lower?

Madrian and her coauthors found there is minimal increased debt and a “precisely estimated zero effect on credit scores” when people save using this practice.⁸ In other words, automatic enrollment leads people to save more and consume less. “Most economists would see that as a good thing—and it’s probably a good thing for most people,” she says.

That said, like all things financial, the devil can be in the details with automatic enrollment. While some companies auto-enroll employees at the rate that provides the highest possible match, others default to only a 2 percent contribution rate, leaving employees short of maximizing the match.

“If you passively accept that default option, you may be leaving money on the table,” Madrian says. “Automatic enrollment is great at getting people in the plan quickly, but if you are auto-enrolled, you don’t want to procrastinate in figuring out exactly how much you should be contributing to the plan.”

Cruising with Confidence

Pensions, 401(k)s, before-tax versus after-tax contributions, employee matches, automatic enrollment—all of this is uncharted territory for new BYU graduates Grace Pope and Shelby Clark to process. “There’s just so much to learn,” Clark says. “Even though it’s a little bit confusing trying to figure it all out, I know I can’t put it off.”

Admittedly, one article isn’t going to have all the answers for every situation—and undoubtedly, there will be detours and unexpected bumps in the road. But if there is any constant when it comes to planning for retirement, it’s that decisions should be based on personal circumstances: age, stage in life, health, family, earnings, and goals.

Even if you feel confident in your current trajectory, don’t get too comfortable in cruise control. Madrian says it makes sense for everyone to carry out an annual financial and retirement review. That’s especially true if significant changes have impacted your circumstances—if you’ve inherited money, changed jobs, had a sudden income increase or decrease, or if you’ve just started your career, like Pope and Clark.

“I study all the ways that people mess up in managing their finances, and fortunately I also study how institutions, like employers and the government, can help facilitate better outcomes,” Madrian says. “Employers really can have a huge impact in helping employees be financially prepared, and it’s critical that people know that.”

Which brings us back to Benjamin Franklin, who, despite living in an era of simple economics, seemed to know a thing or two about financial decisions. Even before penning his celebrated thoughts on saving pennies, he jotted down this missive in the 1735 issue of Poor Richard’s Almanack [sic]: “Look before, or you’ll find yourself behind.”

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Asset Allocation: Fine-Tuning Your Investments

When it comes to deciding how 401(k) money is invested, employees can leave it to the employer or they can take the driver’s seat. “There are always reasons why employees may want a different investment allocation, but for many workers, the default investment fund will be a good option,” Madrian says.

One asset allocation approach that can work for people across all age categories is the target retirement date fund, which gradually shifts from riskier investments (such as stocks) to conservative investments (such as bonds) as an employee nears retirement.

Employees who want to take a more active role can select from options that provide varying mixes of high-risk, high-return stocks to low-risk, low-return mutual bonds. A more aggressive asset allocation would be 90 percent stocks and 10 percent bonds; a moderately aggressive or growth allocation may look more like 70 percent stocks and 30 percent bonds; while a balanced allocation would be an equal split. Conservative allocations would drop stocks down to 30 percent (or less) and select bonds at 70 percent (or higher).

Given these options, what is the right allocation? The general rule is that the younger you are, the more risk you can take. If you have time on your side, you can select an allocation weighted more heavily toward stocks, which are more volatile but have a higher rate of return. Employees closer to retirement will want to skew toward less volatile bonds, understanding that the rate of return will be lower.

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Written by Todd Hollingshead
Illustration by Robert Neubecker

About the Author
Todd Hollingshead is a media relations manager in BYU’s University Communications office, where he mostly writes about faculty research. He and his wife, Natalie (a fellow BYU grad), have four children and live in Springville, Utah. They’re putting all of Brigitte Madrian’s savings advice to work.

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Notes

1. See Transamerica Center for Retirement Studies, 17th Annual Transamerica Retirement Survey: Influences of Educational Attainment on Retirement Readiness (December 2016), 20, transamericacenter.org/docs/default-source/retirement-survey-of-workers/tcrs2016_sr_retirement_survey_of_workers_education.pdf.
   
2. See Todd Hollingshead, “A Pension Saved Is a Pension Earned,” Marriott Alumni Magazine, Fall 2022, 4–9; marriott.byu.edu/magazine/feature/a-pension-saved-is-a-pension-earned.
   
3. See “Bureau of Labor Statistics, US Department of Labor,” TED: The Economics Daily, April 19, 2024, bls.gov/opub/ted/2024/15-percent-of-private-industry-workers-had-access-to-a-defined-benefit-retirement-plan.htm.
   
4. See Greg Iacurci, “88% of Employers Offer a Roth 401(k)—Almost Twice as Many as a Decade Ago. Here’s Who Stands to Benefit,” Personal Finance, CNBC, December 16, 2022, cnbc.com/2022/12/16/88percent-of-employers-offer-a-roth-401k-how-to-take-advantage.html.
   
5. Vanguard, How America Saves 2023, 22, institutional.vanguard.com/content/dam/inst/iig-transformation/has/2023/pdf/has-insights/how-america-saves-report-2023.pdf.
   
6. See Brigitte C. Madrian and Dennis F. Shea, “The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior,” Quarterly Journal of Economics 116, no. 4 (November 2001), 1149-87, jstor.org/stable/2696456.
   
7. See Greg Iacurci, “More Employers Put 401(k) Savings on Autopilot,” Personal Finance, CNBC, December 28, 2021, cnbc.com/2021/12/28/more-employers-use-401k-automatic-enrollment.html.
   
8. John Beshears, James J. Choi, David Laibson, Brigitte C. Madrian, and William L. Skimmyhorn, “Borrowing to Save? The Impact of Automatic Enrollment on Debt,” Journal of Finance 77, no. 1 (February 2022), 403–447, doi.org/10.1111/jofi.13069.