The Downsides of Defaults

Posted by Jeffrey Brown on Jun 6, 2011

Filed Under (Retirement Policy, U.S. Fiscal Policy)

The use of “default options” (i.e., an automatic decision on behalf of individuals who fail to make an active choice) has been shown to exert a strong influence on individual behavior in a variety of settings.  Perhaps nowhere has this effect been more powerful than in the arena of retirement savings, where default options have been shown to dramatically increase participation in 401(k) plans and savings rates and to provide better portfolio allocations.

The widespread use of default options, however, has also been accompanied by a deeper understanding of when default options are appropriate tools for improving individuals’ well-being, and when, in contrast, default options are potentially harmful.

The State Universities Retirement System (SURS) of Illinois has, for approximately 12 years, defaulted new employees into the Traditional Defined Benefit pension plan if they fail to choose a retirement plan within six months of employment. Along with my University of Illinois College of Business colleagues Anne Farrell and Scott Weisbenner, I surveyed nearly 5,000 SURS participants who joined the system between 1999 and 2007 to better understand who defaults, why they default, and the implications of defaulting rather than actively choosing a plan.

Some key findings of the research include the following:

  • More than half of survey respondents who accepted the default option cite information problems or decision complexity as a primary reason for defaulting.
  • One in five respondents believe that because the Traditional defined-benefit plan was selected as the default option, that plan must have been the best option.
  • Over one-third (35.2%) of respondents who defaulted into the Traditional plan would choose a different plan if given the opportunity to do so at the time of the survey.  This is more than double both the fraction of individuals who made an active choice who would like to change plans (15.5%), and the fraction of individuals who made an active choice of the Traditional plan who would like to change plans (14.0%).
  • Individuals who both defaulted into the Traditional plan and would like to choose a different plan if given the opportunity are substantially more likely to cite information problems.

There are numerous implications of the research, including:

  • Because (a) there is no single plan choice that is clearly right for all participants; (b) the choice of retirement plans is highly complex; and (c) plan choice is irrevocable, this is a context in which it is not advisable to rely heavily on a single default option.
  • To the extent that the Illinois legislature considers changes to the SURS system, it should consider ways to provide information that enables quality decision-making by participants.  The legislature should not rely extensively on default options to convey such information.
  • To the extent that default options are used in the SURS system, consideration should be given to allowing default options to vary by participants’ age or income, or to allowing participants to make a one-time change to their plan enrollments.

Given that the Illinois legislature continues to debate the future of state pensions in Illinois, we think these lessons are timely.

One Response to “The Downsides of Defaults”

  • Self-managed says:

    Funny enough, I chose the self-managed plan because I didn’t realize how complex it would be or how much less I would likely retire on. I was very negatively inclined toward the default choice because I believed it must be the worst option for the retiree (me); I thought then that SURS was a state interest. I also would change my decision now that I understand much more about the reasons that favor each option. I agree wholeheartedly with the research implications.