We humans are a tricky lot. If you push to do something, we often react in unexpected ways. That is one of the reasons why dieting, and the many fads associated with dieting, don’t work. We rebel against the constraints.

For many years now, the US has been moving toward defined contribution plans, like 401(k) and 403(b)-type plans. These plans are for employees voluntary. The problem is that despite oftentimes having employer matches, employees don’t take advantage of these tax-advantaged plans.

To address this many firms have made their 401(k) plans opt-out versus opt-in. This has the benefit of increasing participation and savings rates. However there is a hitch. Economists have recently found that employees in opt-out type of situations increase the amount of debt they have elsewhere. Anne Tergesen at WSJ writes:

Automatic enrollment has pushed millions of people who weren’t previously saving for retirement into 401(k)-style plans. But many of these workers appear to be offsetting those savings over the long term by taking on more auto and mortgage debt than they otherwise would have…

“Our conclusion is that people who are auto-enrolled do eventually take on more debt,” said co-author James Choi, a professor of finance at the Yale School of Management. “But they don’t take on more of the kind of debt that would be clearly worrisome,” such as credit-card debt, second mortgages or installment loans, which often charge higher interest rates and are typically used to purchase consumer goods rather than assets.

Thomas Mulloolly at Mulloolly Asset Management asks whether auto-enrollment in 401(k) plans gets things in wrong order. He notes that retirement savings is all well and good, but it doesn’t make sense if the employee has other financial issues that are not addressed. He writes:

if we can construct a model that forces new hires to automatically enroll in a retirement plan, why can’t employers construct a model that forces (“encourages” may sound less strangling) encourages new hires to build a primary after-tax savings account first?

Suppose once a new hire reaches $10,000 in a savings bucket, they would then be invited to join the 401k plan at work? This would reduce the potential for tapping into the 401k account for a new car, paying off credit cards, or student loans, or for that big down payment. Holding a 401k loan is still a loan that needs to be repaid.

One could see how this type of approach could get integrated with a “Save More Tomorrow” type of plan where participants agree to contribute more to their retirement plans based on anticipated raises.

The downside is that employees, in the meantime, could be leaving money on the table If the employer is offering a match of employee contributions then any delay in joining the plan risks losing out on those potential contributions. That aside, it makes perfect sense that having your financial ducks in order could only benefit the participant.

Employees aren’t stupid. They respond to incentives. If you push them to contribute to their 401(k) plans, Newton’s 3rd Law kicks in, and you get a reaction in the opposite direction.* Making employees aware of these issues by enhancing financial literacy, by whatever means possible, can only serve to help both employee and employer alike.

*Then again we shouldn’t take investing advice from Sir Isaac Newton.