An employer-sponsored retirement savings plan, such as a 401(k) or 403(b), is a valuable employee benefit. However, a plan that offers employees too many choices with which to customize their account may make the outcomes worse instead of better.
It may seem that more options would make an organization’s retirement plan more appealing, but there could be unintended consequences. Recent research in social psychology has argued that too many choices may create confusion, and may even be demotivating and discouraging to employees. Despite plan education efforts, many employees are ill informed about the available options, either making poor choices or not choosing not to participate at all.
It’s also important to note that too many choices can also make it more difficult for the employer to be clear about plan options and plan expenses.
Donald B. Keim and Olivia S. Mitchell, Wharton School professors, studied what happened when employers streamlined their retirement plans by comparing plan participants’ contributions and assets allocations before and after the changes. In a paper titled, “Simplifying Choices in Defined Contribution Retirement Plan Design,” Keim and Mitchell report that limiting the number of investment options available resulted in the following improvements:
In addition to their diversification benefit, models offer features that may help individuals avoid some common investment mistakes, such as being too aggressive or too conservative and ill-advised market timing. These funds are managed with a disciplined, long-term approach, and are automatically rebalanced to keep investors’ allocations intact.
Employer-sponsored retirement plans are now the primary source of retirement income for most employees. This means employees are the architects of their own destiny when it comes to retirement. Employers can, however, lay the groundwork by using simplified plan design and a strategic communication plan to help employees act.