It’s going to be a New Year in a couple of days and I hope you’re enjoying the last of 2013. Now is the time to make a few New Year’s resolutions and write them down. Two of the most common resolutions are to get fitter and to save more money. These two are on my list, too, and today is your lucky day because I will share a surefire way to save more money next year. You’re on your own for the fitness resolution. I will be struggling with that one, too.
A couple of weeks ago, I came across some research by Richard H. Thaler, a professor of behavioral science and economics at the University of Chicago’s Booth School of Business. Whew, that was a mouthful (if I was speaking.) Anyway, this research paper shows how you can save more tomorrow. This program is actually dependent on the employer to help you save more for retirement. We’ll just go through it first and then see what we can do at the end.
Save More Tomorrow (SMT)
The SMT plan has 4 basic components:
- Employees are approached about increasing their retirement saving contribution about 3 months before their scheduled pay increase.
- Once they join, their contribution automatically increases after their raise.
- The contribution continues to increase when they get another raise.
- Employee can opt out at any time.
Wow, you can see this would be a brilliant plan for an average employee. Most of us are NOT saving enough for retirement. It’s hard to increase our retirement saving because we would see an immediate decrease in our take home pay and that’s painful. The SMT plan is ingenious because of step 1.
Everyone wants to save more. We make resolutions and try our best, but our psychology works against us. What step 1 does is to take our good intention and shove it out 3 months. Sure, I can save more in 3 months once I get a raise. I won’t see a drop in take home pay and in 3 months I’ll have forgotten about signing up for this automatic increase. The take home pay increase will be less than expected, but that doesn’t hurt at all compared to seeing the take home decrease.
Another reason why this is a great plan is due to inertia. Most employees don’t increase their retirement contribution because it’s easier to not change anything. Every few years, the government increases the 401k and IRA contribution limit, but most people just leave their contribution the same or not save at all. This plan puts inertia in our favor by automating the increase. Most employees in the study left their SMT plan alone and they benefited because of it. They automatically saved more for retirement every year without having to do anything.
Oh, I’m not disappointed with the SMT plan itself. It’s a great plan, but I can’t believe I haven’t heard about this until recently. The SMT plan was first implemented in 1998 at a midsize manufacturing company and it went very well. Employees were able to save more and that’s a good thing. One thing to note is that the executives also benefited from the higher retirement saving rate. Only a certain percentage of the employer contribution can go to the executives and if the regular employees are not saving, then the executives won’t be able to maximize their retirement benefit either. So the executives also have a big incentive to put this plan into effect. What’s disappointing is that the SMT plan isn’t more common 15 years after its inception.
What can you do?
What can you do if your employer doesn’t offer the SMT plan? Well, you will have to get a little bit more proactive. At my old job, they had an annual review every year around this time. I would know if I’ll get a raise at the beginning of April. I’m sure you have a similar process at your place of employment.
What you need to do is to increase your retirement contribution as soon as you get the results of your annual review. Usually you won’t see the raise for a few more weeks and that’s plenty of time to get things set up. The most painless way to do this is to split the raise. For the present, you would get half of your raise and in the future, you get the other half. Of course, if you’re not hurting for cash, then it’s better to give your future self a bigger slice of the pie.
You won’t see a decrease in your take home and you’ll fulfill your resolutions all in one shot. Well, you shouldn’t be making a blanket resolution like “save more money.” See my tips on how to make and achieve your New Year resolutions to get on the right track. Unfortunately, this can’t be automated so don’t forget to increase your contribution when you get your pay increase letter.
Does your plan have an automatic increase option? Don’t you think this would be helpful?
Farewell 2013 and Good luck in 2014!