Five Things Retirement Plan Participants Get Wrong

Take target-date funds (TDFs). This common investment is misunderstood in various ways by plan participants. About a third said they believe their account balance in a TDF will never go down. In the same survey, 37% said they believe a TDF guarantees income in retirement, and research by AllianceBernstein found that a “large number” believe it guarantees lifetime income.

‘I’ll never be able to retire, anyway.’ 

Fearful thinking is responsible for a common misconception among participants, according to Michael Fein, managing partner of CIC Wealth Management in Owings Mills, Maryland, who says the big misconception his firm sees is participants’ belief that they’re never going to retire because they won’t be able. Fein tells PLANADVISER, “They say they’re never going to have enough money. They’ll think about it next year.” A related belief, also wrongheaded, Fein says, is that their starting deferral will be adequate to fund a secure retirement, and that there’s no need to increase as the years go on.

He suggests an education strategy blending commonsense advice and digestible numbers to zap these misconceptions. For example, he tells participants they can give up $7.82 each week without feeling it. “Don’t order fries with your lunch,” he says.  

‘I can’t afford to increase my contribution.’

To get someone to the optimal 15% deferral rate takes time, Fein says. It’s nearly impossible to get someone to commit to that contribution rate on their first day of work, but Fein feels getting plan participants to increase by 1% every year or even every six months is doable. The dollar amount on a 1% increase is very manageable, and most people will not even feel it, he says.

He approaches participants armed with pen and forms, he says, explaining that a useful strategy is to tap the participant on the shoulder, hand them the pen and say, “Sign here.” Then he explains that the form increases their deferral from 4% to 5%, for example, and reassures them that this 1% increase will barely be felt, but will have a big impact on retirement savings over time. 

'I don't need to worry about retirement now.'

Time discounting—when people discount something as not important because it is so far in the future—is a widespread misconception by participants, says Tim Noonan, managing director of capital markets insights, at Russell Investments in Seattle. This behavioral economics theory attempts to explain why people make poor decisions that will haunt them in the future.

Not putting money away for retirement is like not wanting to get fat, but eating too much, Noonan says. He calls this the No. 1 misconception and claims it makes all others tiny in comparison. “Just because something is far off into the future does not mean that it should not command attention in the present."

Simply getting participants to discard this one misconception alone can help them step onto a path of greater financial security, Noonan contends. Cause and effect are far removed from one another in time and space, according to Peter Senge, an organizational learning expert, Noonan says, and that's the reason most people have trouble seeing that modest sacrifices in the present can lead to enormous rewards in the future. “They fail to develop the muscles that help them balance their consumption in the present with their need to consume in the future,” Noonan observes.

He says one helpful education strategy is the use of concrete examples of how choices will affect outcomes. “Take a car, for example,” he says. “Everyone needs wheels. Here’s one investor who does everything right, doesn’t put things off, saves money and so on. In  20 years, when this investor is living off his nest egg, he’s driving a Lexus.” He contrasts this successful investor with another (he is careful to point out this person as neither stupid nor evil, just inattentive to the future). Without making the proper arrangements, this investor winds up in a Camry.

Examples can help make a picture of the future much more understandable, Noonan explains, and the difference between two well-known brands is immediately clear. “People have very strong preferences about how they want to consume,” he says, “as well as well-developed consumer instincts.” 

‘I’m responsible?!?’

A close sibling to time discounting, Noonan says, is the notion that someone else—people’s employers, the government, the capital markets—is responsible for our financial security. “No one is responsible for our financial security but us,” he says. These other entities contribute to successful planning, saving and investing, but the responsibility ultimately rests on each of us.

“I think if this individual responsibility were much more explicit, including guidelines on how to discharge it, it would be harder for people to deflect making the required decisions that set the stage for a secure future long after they have stopped working,” Noonan says.

Unfortunately, it is culturally unpopular in this country to remind people about personal responsibility, Noonan feels. “It seems too schoolmarm, or a values discussion we are uncomfortable with,” he says.

Noonan thinks the best method to show people their own responsibility is to continually demonstrate to them their own progress, through the personal funded ratio. An adviser could say that a 48-year-old should be between 65% and 75% funded, and at age 32, a 10% funded ratio would demonstrate a good path to be on.

It does not have to be done in one fell swoop, he emphasizes. At 32, people are just getting going. They need to develop some important muscles. After all, in the early stages of beginning to plan, people often have very little to accumulate, so the focus should be on what is a reasonable amount to contribute, Noonan says. In the middle stages, the amount of what’s been accumulated becomes more relevant, and the picture takes on more texture as the individual gets closer to the finish line. 

‘Oh, the plan has costs?’

Commonly, says Kevin Stophel, principal at Kumquat Wealth, an advisory in Chattanooga, Tennessee, participants think their retirement plan doesn’t cost them anything. “They are quite unaware of how to assess plan costs,” he says.

Since few participants are financial professionals, they don’t have a context to think about finances, Stophel points out. They may live paycheck to paycheck, and any financial planning or budgeting can be  unfamiliar concepts. “Even with their checking accounts,” he says, “they don’t look under the hood.”

Stophel contends that education is great in theory but not in practice. “Even the fee disclosure is not much benefit to participants,” he feels, “because they look at a couple of things, perhaps the asset allocation and the statement projection. Then, everything else tends to be noise.”

Simply put, the statements have a lot of information, Stophel says. At least eight or nine topics are covered, in addition to the lists of investments, and it is possible it’s just too much for the average plan participant.

He would like to see education on demand about how to assess plan costs, which could be provided inexpensively by custodians. “Instead of trying to educate everyone directly,” he says, “it could be made available to those who have some interest.” A large subset of participants are not math people and aren’t going to get it, and may not even want to. But those who have some interest should have access.