Someone who has overwhelming immediate financial and needs like the burden of a catastrophic illness might reasonably prioritize those expenses over saving for retirement, but even taking financial and other factors into consideration it’s pretty clear that fewer people participate than should.

Future rewards, the business of participation

In one survey of three large companies only about one in three employees signed up for their retirement plan within six months of beginning work and that rate only jumped to about two in three after three years working at the company. You might argue that indeed many of those nonparticipating workers couldn’t contribute, they didn’t have the discretionary income each month to devote to a distant retirement from work or business.

To counter that argument let me focus on a specific group of workers. Some US career workers nearing retirement age can withdraw money including the employer match from the retirement accounts immediately and without any penalty. All they have to do is designate some part of their paycheck to their retirement fund then they get the employer match in each paycheck and then they can withdraw both their own contribution and the employer match right away.

This is arbitrage – the employer or the entrepreneur match represents free money just for the taking and is not an inconsequential amount of money. For most employees the employer match would be thousands of dollars a year, but only about 40% of eligible workers surveyed in one study actually took advantage of this free money. The remainder are losing perhaps thousands of dollars each year right in the pre-retirement period where every dollar is critical, and this lack of participation isn’t limited to the United States.

Another study examined the class of retirement savings plans in the United Kingdom. These were fully employer supported, they required no personal contribution. Let me emphasize that all people had to do was sign up and their employer would start contribute money to retirement account and still only about half of eligible employees took action to enroll in the plans, the rest simply didn’t sign up for the benefits coming to them.

There’s a one-word explanation: inertia

Why don’t people participate in retirement plans even when they know savings is important and they can do so very simply often by mailing a single card or clicking on a single webpage? There’s a one-word explanation: inertia – when you aren’t already enrolled in a plan it can be hard to start you have to sacrifice some of your monthly income right now and you have to make a decision about how to invest your money, that can be complicated and discouraging.

The proportion of people participating in a 401(k) or similar retirement plan actually decreases when the employer offers more investment options. For example, companies and only offered to mutual funds to choose from have higher participation than those that have 10 funds and much higher than those that have 40 or more options of success.

As I’ve emphasized throughout this article people want to make decisions that they won’t regret later and complicated decisions that involve many potential funds for investment are more likely to generate regret. What can be done about this?  Some employers have moved to an opt out approach for retirement savings. But can this work for the regular entrepreneur who tries to stay in business.

That is employees are automatically enrolled in the retirement plan shortly after hiring with some default contribution level and they stay in the plan unless they expressly choose to withdraw, that’s what’s meant by an opt out. It’s a pre-commitment strategy and that workers are committed to a particular decision ahead of time, but it’s not a binding pre-commitment, they can choose to leave the plan when they wish.