Board Reflections: An Interview with Brigitte Madrian

Board Reflections is a series of interviews with Commonwealth board members discussing their views on emerging financial challenges, innovative solutions, and the future.

It is difficult to miss something you never had.  And what you call something makes a difference.

Brigitte Madrian, a member of Commonwealth’s Board of Directors, expanded on these insights in a recent interview with Senior Vice President Melissa Gopnik.                                                                   

Madrian said employer-sponsored savings plans are so effective at promoting retirement savings because the savings happens through automatic payroll deduction before the worker sees the paycheck.  The federal government had this insight in using automatic payroll deduction for payment of income taxes.

But many workers do not have access to an employer-sponsored plan.  Some states are now trying to help these workers by rolling out plans that use the same automatic funding process.  Madrian noted that the basic idea is to “do it through payroll deduction so that you never see the money, you never miss it, and then it’s there for you when you reach retirement.”

Madrian also referenced the need for new institutions and different approaches to help meet the need for retirement savings for the growing number of people who are working for themselves rather than working for an employer.  Although these “new economy” workers are still a small fraction of the total workforce, they are a growing segment of the employed population, and that growth is likely to continue given how technology is reshaping the nature of work throughout the economy.

Madrian also talked about another problem with the current retirement savings system:  many people are taking money out of their accounts well before they reach retirement.  She cited estimates that for every dollar being saved for retirement, about forty cents are coming out before people turn fifty-five.

Madrian said there are two solutions: “One is to get people to save more in the first place for retirement, recognizing that not all of that savings is going to make it. But another approach that is likely to be more effective from a psychological standpoint is to have individuals save in more than one account.”

This is where naming matters.  One account can be explicitly designated the retirement account, one a rainy day savings account, and additional accounts can be labeled for medical expenses or college costs.  Madrian said this would exploit the psychological tendency referred to as mental accounting or partitioning.  “If you can label something, even if there's no hard constraint against using the money in a way it's not labeled, people still have a lot of trepidation about using that money for other purposes.”

Madrian thinks having multiple named savings accounts – each funded through automatic payroll deduction – would encourage greater financial discipline by imposing a psychological cost for using an account’s funds for reasons other than the intended purpose.  Although this cost is not huge, Madrian believes it is sufficient to actually deter people reneging on their savings goals and improve overall savings outcomes.

Brigitte Madrian is the Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School.  She is also a research associate and co-director of the Household Finance working group at the National Bureau of Economic Research, and an editor of the Review of Economics and Statistics.

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