URL: http://www.entrepreneur.com/article/225544
Small-business owners don’t save enough for their retirements. A December 2012 report by senior economist Jules Lichtenstein of the Small Business Administration, finds that self-employed people are less likely to have a retirement plan than people who work for others, even after taking to account many differences between the two groups of people.
Moreover, the fraction of self-employed people with retirement plans is surprisingly low. An earlier report by Lichtenstein shows that only 2 percent of small-business owners have a Keogh plan (a type of retirement plan for the self-employed) and only 18 percent have a 401(k) plan.
Although some believe that this low level of retirement savings demands the creation of additional retirement plans for small businesses, I don’t think that’s the answer. Washington has already created a lot of ways for small-business owners to save for retirement. But this cornucopia of plans has done little to boost the fraction of businesses whose owners save adequately for it.
Related: 4 Obstacles to Early Retirement and How to Overcome Them
Fixing the problem requires addressing how small-business owners think about retirement. Entrepreneurs are more optimistic than the rest of the population, researchers have found. While that optimism has many virtues, it leads small-business owners to believe that their companies’ futures will be rosier than they actually turn out to be. Small-business owners think their businesses are less likely to fail, will generate greater profits and will sell for more than they actually do. These overoptimistic projections about the value of their companies lead many small-business owners underinvest in their retirements.
Behavioral economists have suggested some approaches that would boost the amount that small-business owners save for retirement. Here are a few:
- Make small-business owners’ retirement plans automatic. While small-business owners generally have the option to establish comparable retirement plans to those available to wage workers, they have to take the initiative to establish those plans by contacting banks and financial advisers. The need to be proactive about establishing a retirement plan lowers the odds that people will create them. If Washington made the establishment of these plans automatic, the fraction of small-business owners establishing retirement plans would likely rise.
- Make it harder for small-business owners to opt out of the creation of retirement plans. Researchers have found that making people opt out of plans rather than opt in boosts participation. Policy makers could preserve small-business owners’ freedom of choice but give them a nudge to set up retirement plans by changing the default from having no retirement plan to having a retirement plan. Those who didn’t want to participate would be free to opt out, but they would have to actively do so.
- Make setting up retirement plans simpler. The complexity of the process of establishing retirement plans deters small-business owners from doing so. Because people are more likely to choose to enroll in retirement plans if the process is simple, allowing people to set up these plans online with one or two clicks and only a couple of choices would increase the number of people willing to do so.
Behavioral economists have figured out that human psychology has profound effects on the way in which people make decisions about a wide variety of things, including how to save for retirement. If policy makers want to boost the number of small-business owners saving sufficiently for their retirement, they need to incorporate this information into the design of small-business owners’ retirement plans, not just make more types of plans available.