Retirement Advisor Council Blog

Over the past quarter-century, plan sponsors, their advisors and retirement plan recordkeepers have invested hundreds of millions of dollars to educate the workforce about the benefits of participating in a 401(k) plan. However, despite these extensive efforts, the results have yet to substantially improve the retirement readiness of working Americans. Why?

One reason is that they have failed to consider the financial literacy needs of employees as well as their level of financial stress, and the two go hand in hand. If employees don't do basic budgeting, then they may never be financially healthy enough to be able to save money regularly and ramp up these contribution levels over time.

When creating an effective financial education curriculum for your plan participants, get back to basics: Make sure you meet the basic financial literacy needs of plan participants. Here are some key elements of financial literacy to include:

1 – Think and act long term - Like taking a healthy long-term approach to diet and exercise, financial success comes to those who incorporate healthy habits into their lifestyle rather than opt for the latest crash diet or gimmicky exercise fad. Teach participants how to create a long-term strategy in support of life-long goals as well as how to track monthly spending and income. This can help them free up money that could be channeled towards those big, potentially daunting goals.

By getting participants to focus on the big picture, you can help them resist such dangerous distractions as chasing hot-performing investments and overreacting to short-term market "noise."

2 – Time is on their side - Participants need to know that one of their most powerful allies is time. Starting at age 25 can make things so much easier than waiting a decade and having to play catch-up. For example, by saving $5,000 a year at an annual return of 6%, a 25-year-old could hypothetically accumulate $820,238 by age 65, a 40-year span of compound earnings. Even if the individual stopped contributing new money after age 35, he would have $69,858 after 10 years, which would then grow to $401,229 without adding a single dollar afterwards.

Compare this with the cost of waiting 10 years. A 35 year old contributing the same amount over the remaining 30 years to age 65 would accumulate $419,008. The cost of waiting the 10 years to begin to contribute to retirement savings is $401,229. Another way to look at this is that the person who contributed from age 25 to 35 would end up with more than $400,000 by saving just $50,000, while the one who saves $150,000 over the remaining 30 years would end up with about the same amount. Who would get more bang from their savings buck?

These types of illustrations can bring home to young plan participants how important it is to contribute now and not wait a moment longer.

3 – Understand investing basics - Participants don't need to be sophisticated investors, but they do need to know the basics. They should be comfortable with asset allocation, comparing investment performance with the right benchmark, knowing the difference between actively managed and passive investments, understanding mutual fund expense ratios, and emphasizing long-term performance over short-term returns.

By helping participants understand the basic building blocks of investing, you can help to empower them to make their own investment decisions and to be able to track their fund and portfolio performance against the relevant benchmarks, rebalance their asset allocation as needed from time to time, and monitor their progress towards their retirement savings goals.

4 – Beware the pitfalls of plan loans and in-service withdrawals - One important area where we need to do a better job is in educating participants about the dangers and costs of plan loans and in-service withdrawals as well as the long-term costs of cashing out of a plan rather than rolling it over and keeping it in a tax-deferred account when they leave a job.

The pitfalls include opportunity costs of lost potential earnings when the money is absent from the account and not generating compound returns as well as potential taxes and penalties if permanently withdrawn or owed when an employee leaves a place of employment.

The costs to our society of having a generation of workers who aren't financially ready to retire when they arrive at retirement age could be devastating. The costs to individuals who can't afford to retire or who have to make serious financial sacrifices through retirement can be heartbreaking. We need to work together to make sure that doesn't happen. We simply need to do a better job educating our plan participants.

Contributors: Charlie Avallone, Jason Chepenik, Mike Kane, Deb Rubin, Sharon Schmid, Jamie Worrell

Although Americans are being asked to bear more responsibility for their retirement, many lack the financial literacy skills or interest to answer the most vital questions, such as: “How much should I contribute? In what options should I invest? How much money will I need in retirement? And how will I manage the many financial risks I’ll face as a retiree?”

Solutions to the retirement readiness challenge usually take one of two directions: the improvement of education or the implementation of automated features in retirement plan design. Globally, myriad solutions have emerged: from mandatory participation in an employer’s defined contribution (DC) plan to auto-enrollment of employees into the DC plan, to voluntary DC/DB (defined benefit) and hybrid elements.

Plan design is critically important, but it won’t address the broader societal problem of poor financial literacy. The shifting risk from DB to DC — from employers to employees — shines a spotlight on a far greater problem than the retirement readiness challenge: basic financial illiteracy.

Workplace initiatives needed
We need to improve the financial literacy of working adults. Essential efforts are already being made to improve financial literacy among students, but we also need forward-thinking initiatives specifically designed to help our current workforce make better financial decisions. This applies to retirement planning and saving as well as other aspects of financial life. The two phases in everyone’s financial life –– retirement and non-retirement –– while seemingly distinct, affect one another profoundly.

For instance, workers who use payday loans are less likely to contribute to their retirement plans. How can we expect our messages to succeed in directing plan participants to boost their retirement contribution levels when young adults typically enter the workforce saddled with student loan debt? And how can those messages lead to the desired behaviors when plan participants don’t have a solid grasp of financial planning and budgeting concepts?
Many employees need help just to understand budgeting basics, which is fundamental for their current and future financial well-being. How can individuals be expected to set aside enough money to save properly for retirement, or manage their money in retirement, when they haven’t mastered how to make sure that income spent each month doesn’t exceed income earned?

Adults need guidance on how to gain control of their monthly spending habits and how to confront our commercial world by determining wants versus needs.  
This lack of basic understanding and financial self-control has fed a booming payday loan industry that, as noted above, presents an obstacle to broader retirement plan participation.

We need to do more to help our workers understand and manage all aspects of their finances better. That’s a crucial first step in helping to improve retirement readiness and promote successful lifelong personal financial management.

Look for continuation of this blog series discussing adult financial illiteracy.  We welcome you to share your ideas for better financial futures.

Contributors: Charlie Avallone, Jason Chepenik, Mike Kane, Deb Rubin, Sharon Schmid, Jamie Worrell

Drafting comments to the Department of Labor over the last month, I reflected on the factors that might have inspired sensible regulators to be so focused on price as to conceive the idea of a guide to accompany lengthier 408(b)(2) disclosures.   I have come to the conclusion that the culture of Cheap that has become dominant since 2008 is partly to blame.  Necessity has brought millions to share the belief that cheap is good.  Eager to cater to an audience struggling with declining personal incomes, opinion leaders in the media and policymaking circles reinforced the notion in articles, public speeches, blogs, and social media posts.  The show Extreme Cheapskate televised on TLC epitomizes the cultural wave.  Imbued by the dominant culture, many American workers accept it as self-evident that cheap is good. 

To some extent, the retirement plans industry benefits of cheapskates’ rise in popularity.  The allure of conspicuous consumption impeded babyboomers’ ability to achieve retirement success en masse.   When tightwads are hip and saving is in, money flows to retirement coffers more readily.  Millennials appear on track to achieve retirement success in greater numbers.  It behooves the industry to make this trend a lasting one.  However, it is important that we not get enitrely caught up in the cultural trend.  Cheap comes at a price.  Often, cheap is in bad taste; or cheap breaks down easily.   There are reasons why employers should not buy their retirement plan services on Craigslist or at the Goodwill store.  Plan fiduciaries have an obligation to ensure compensation paid for services provided is reasonable, but they also must act prudently in the interest of participants. 

Emphasizing cost and downplaying benefits in the content of disclosures affects plan sponsors’ choice architecture at the detriment of American workers’ retirement success.  A retirement plan decision maker’s obsession to achieve everyday low cost can affect retirement readiness in undesirable ways.  The urge to cut corners may lead to reductions in services such as participant counseling or in-person plan reviews that undermine the effectiveness of the national retirement system.  Keeping policy makers (regulator or lawmaker) and decision makers (plan sponsor, committee member, advisor, legal counsel, service provider, or investment manager) focused on acting with prudence is critical to the integrity of the system.