Match-Making For Savers

By Albert B. Crenshaw
Sunday, May 15, 2005

In theory, 401(k) plans and other tax-preferred savings programs can provide a good retirement fund -- if the worker joins up, contributes a substantial chunk of his or her pay, makes the right investment choices and doesn't drop out or tap the account for non-retirement expenses.

That's the theory. The reality so far isn't pretty. Today, the median account balance - median means the midpoint, that half are larger and half are smaller -- of 401(k) and individual retirement accounts combined, for households headed by someone 55 to 59 years old, "on the verge of retirement," is about $10,000, the Brookings Institution's Peter Orszag noted last week.

But a couple of recent findings and developments may offer avenues that will help.

First, Orszag, Brookings colleague William Gale and several other experts, with the aid of the Pew Charitable Trusts and H&R Block, have been studying whether low- and moderate-income taxpayers would be more likely to divert at least a portion of their tax refunds into an IRA if they were offered a matching contribution of some amount (IRAs, unlike 401(k)s, have no equivalent of the employer's matching contribution). So, using real money provided by H&R Block, they arranged to offer varying matches to a random sample of Block clients who were getting refunds and looked at how they responded.

Now, you might think that what amounts to free money would be an obvious attraction, and that more free money would be more attractive, but some studies of 401(k) plans have suggested that higher matches don't necessarily produce higher participation.

But the new study found that "rational man" (and his updated counterpart, "rational person") is not entirely a figment of economists' imaginations. While only about 3 percent of taxpayers were willing to divert refund money into an IRA if they received no match, 10 percent of taxpayers contributed if given a 20 percent match, and 17 percent did so if given a 50 percent match.

"You see very significant increases, very statistically significant and meaningful increases, in participation rates as you move up the match rate from 0 to 50 percent," Orszag said at a meeting last week at which he described the results.

As the rate of match rose, so did the amount refund recipients contributed to their IRAs. The 3 percent who got no match but were willing to contribute anyway put an average of $856 into their IRAs, while those who got a 50 percent match contributed an average of $1,300 - and got the match on top of that.

The findings also contradict the conventional wisdom that low-income people won't save, or won't save in retirement accounts, Orszag said, noting that even among taxpayers receiving the Earned Income Tax Credit, a program aimed at low-income workers, the participation rate rose at higher match rates.

But the impact of the rising match in this study appears to have been much greater than what is seen in the federal Saver's Credit, which varies, depending on the taxpayer's income. There, getting a higher credit does correlate with increased saving, but not as much as with the Block match.

The Saver's Credit, a special program to encourage lower-income people to save for retirement, allows workers with incomes below certain thresholds to take a credit that reduces their taxes by as much as $1,000 ($2,000 for a couple) if they contribute to a 401(k) or similar plan or to an IRA.

But the Saver's Credit is very complicated, and Orszag and Gale suggested that the effect of information and advice in their experiment - the match was explained to taxpayers individually by Block return preparers - seems to have played a major role in making the match more attractive. Also, Block made the entire process of setting up the IRA, getting the refund and contributing some of it much simpler than it would be in real life.

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