Outside the Box: Why ‘nudging’ works: People need a push when it comes to retirement savings

Sunday, 15 October 2017 05:00 Written by  Read 11 times
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Studies show that we are living longer and retiring later, but too many of us are not adequately preparing for retirement. People who do not save for retirement often do not have access to an employer-run retirement program, do not understand how much money they will need to save, or lack the financial knowledge to make the best investment decisions.

For many, working longer seems to be the new retirement strategy.

There are many reasons why individuals do not always act in their best interests when it comes to saving for retirement. In his book “Misbehaving – The Making of Behavioral Economics,” Nobel Prize-winning economist Richard Thaler identifies some reasons why people often fail to save for retirement. These include inertia that keeps people from even taking action to begin to save; loss aversion that keeps people from taking actions that reduce their paycheck; and a short-term focus on actions that provide immediate gratification rather than planning for the future.

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Because of these natural behavioral factors, a defined contribution retirement savings program often fails to overcome the following behavioral barriers and leads to less than optimal outcomes:

• Lack of access to employer-based retirement savings plans. According to the U.S. Government Accountability Office (GAO), 84% of the workers who do not participate in workplace retirement savings programs reported that the main reason was not having access to a workplace retirement program rather than a failure to participate.

• Short-term horizons. Many workers tend to be more concerned about day-to-day financial needs than their future financial plans. In addition, if employer retirement investment decisions are complex, inertia can take over and they may simply never take action.

▪ Limited financial knowledge. Not knowing the ABCs of finance, such as maintaining a budget or managing credit, makes workers much less likely to save for retirement. As the GAO has reported, without proper knowledge to figure out the numbers or work through the complexities, workers are much more likely to over or under estimate how much they need to save or just give up on saving.

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Strategic behavioral nudges make sense

Behavioral tools or nudges can help overcome the natural behavioral factors that undermine retirement savings. Here are some of the ways policymakers can make better use of behavioral tools.

• Expand employer-based savings. AARP reports that workers are 15 times more likely to save if they have access to retirement savings plans through their employers. When employees are offered a plan, about 70% voluntarily participate. When workers are automatically enrolled in a plan, with an option to opt-out, participation jumps to about 90%.

• Keep it simple, easy, and make the default automatic. Behavioral studies tell us when faced with overly complex choices, people are more likely to take the option that requires the least effort. To make savings easy, auto-enrollment with an option to opt-out and auto-escalation have had a noticeable effect in boosting annual savings.

• Add financial education. Improving financial literacy can make a big difference. Many studies have suggested that workplace-based plans with financial education are the most effective tool to improve financial literacy and increase retirement savings. A study by the Global Financial Literacy Excellence Center found that “… employees who completed a financial education module were more likely to start contributing and less likely to have stopped contributing to the defined contribution plan.”

We often hear stories of parents and grandparents who worked for the same company for 20 or 30 years and the company helped them prepare for retirement by providing a pension that would last a lifetime. Many companies used to use these traditional defined benefit pension plans, which allowed a worker to make regular payroll deduction contributions to the employer who, in turn, would rely on investment experts (e.g., a chief investment officer and staff) to manage and invest the funds. This put the burden on the employer to focus on investment returns, rebalancing the portfolio, and keeping costs down.

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But today’s more common defined contribution system of retirement savings moves the onus on to the worker to perform many of the financial tasks previously handled by the employer and its investment experts. For many baby boomers and future generations, we have to be our own chief investment officers, deciding how much to save, and navigating the complexity of investment strategies and options to make educated choices that fit our needs with the hope that our savings will provide us with sufficient income to last a lifetime.

We seek out expertise as part of our daily lives. If the pipes burst in your house, call a plumber. Your check engine light goes on, you bring it to the mechanic. Planning a home renovation? Hire an architect. But when it comes to one of the most important financial decisions an individual can make — how to save and invest for retirement — we are often left on our own.

State policy leaders are at the forefront of applying behavioral insights to program design in a way that will help millions of Americans begin to save more for their retirement. In states such as California, Connecticut, Illinois, Maryland and Oregon, policymakers are establishing programs to expand access to retirement savings programs. A recent survey of workers by the Pew Charitable Trusts shows that they favor these state savings programs if their employers do not provide one. As part of these programs, states are making sure they incorporate behavioral tools such as auto-enrollment and auto-escalation and workers welcome efforts that help nudge them to start saving or save more for their retirement.

Angela M. Antonelliis the executive director of the Center for Retirement Initiatives at Georgetown University’s McCourt School of Public Policy.

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