Defined Contributions Insights Magazine
January/February 2010
Financial Literacy and Retirement Education
A best practice guide for the future.
by Robert A. Benish
Over the past 10 years, the term financial literacy can be found more frequently in the media and on the agendas of schools and government organizations. Most financial literacy efforts have been focused on educating primary and secondary school children. The reality is that your employees, including the participants in your plan, may need a healthy dose of financial literacy as much as their children.
In this article, I am going to focus on how financial literacy impacts you, as a plan sponsor responsible for helping your employees make the right choices regarding their retirement plans.
Before you begin to deride the premise, attend your company’s next retirement education workshop and ask random people some basic questions: “What is a stock?”, “What is a mutual fund?”, and “Do you live on a budget?” You may be surprised and dismayed by the results. Of course, these adults may be saving in your company’s 401(k) plan, but are they really listening? More importantly, are they really learning what they need to know to make the best financial decisions as they save for retirement?
For 25 years, I have managed and led thousands of retirement education meetings and produced award-winning communication campaigns for hundreds of companies. Thanks to the dedication of many plan sponsors and their companies, we have successfully increased participation in their companies retirement plans. Unfortunately, we could only go so far. As any financial planner will tell you, in order to create a financial plan for an individual, you need to have a complete picture of that individual’s financial resources. For most of us working in the retirement savings arena, our only barometer of retirement readiness comes from at most three sources — the employee’s 401(k) balance, projected company pension, or estimated Social Security benefits.
Thanks to advice products and available tools on the internet, your employees do have access to the calculators they need to create their own plan. The truth is that many people never do it. The result is that your employees may be unprepared to effectively manage their own retirement financial portfolio. Furthermore, the decisions they are making today which have the greatest impact on their future may not be made based upon fact but rather based on their own personal perceptions.
For example, last June in Washing ton, D.C., testimony around target date funds revealed some interesting and disturbing truths. When it came down to participant understanding of exactly what they were investing in when they chose a target date fund, it was disturbing to discover that many investors believed that these investments were some type of a guaranteed product.
We can’t blame the providers and fund companies for not making an effort to explain exactly what people are investing in when they selected an investment. After all, everyone who selects a target date fund can receive a detailed prospectus, fund fact sheet, and an assorted of educational material that clearly states that this fund is not an annuity or guaranteed investment contract. The sad truth is that most people don’t read the materials and make assumptions based upon their perceptions of what they believe they know. This is a case of financial illiteracy.
According to PSCA’s Target Date Fund Study released in 2009, 62 percent of plans will include a target date fund in the lineup over the next one to two plan years. This means that more of your employees are going to choose an investment selection that may not be what they think it is. And, as a plan sponsor, you need to be increasingly aware of how you need work with your provider in communicating about your fund options.
Is Auto-Everything the Solution?
Another trend that may impact your employees and their financial literacy is the increasing number of auto features found in many plans. Auto enrollment and auto deferral plans have proven to be excellent tools to get employees in your plan and keep them in the plan in the belief that when they see balances grow they will become more engaged in retirement savings. It relies on inertia in a positive way, which keeps many people from opting out. According to the PSCA 52nd Annual Survey reflecting 2008 plan experience, 39.6 percent of plans have an automatic feature an increase over 2007 of 4 percent. Of the plans that offer auto enrollment, 83.6 percent use this feature for new hires only, however, there is an increase of plans going back to apply auto enrollment to all non-participants.
Auto enrollment and deferral does not always lead to auto-education. It is human nature, which we learned as children, when we first started using a knife to cut our own food, or when we first took off the training wheels on our first bike, that sometimes we need to stumble before we walk. If as a parent you did everything for your children, how would they learn? Without assuming that in addition to all of your other duties, you now have to become the ad hoc “parent” in guiding your employees’ through the retirement maze, nevertheless, you do have some responsibility to provide them with education to make the right decision. Therefore, simply making it too easy for them through auto enrollment and auto deferral programs may not be helpful in the long run unless you also continue to provide them with financial education materials and tools.
Let me provide you with another example of unintended incompetence. When I was growing up, I first learned to drive a car that had a “stick” — a manual transmission. Most people today, young and old, seldom drive any car other than an automatic transmission. If you want a laugh, (and have a friendly mechanic who will replace your clutch without a mortgage payment) ask someone who has never used a manual transmission to move your manual transmission equipped car. Several curses and stalls later, they will emerge from the car red-faced. It’s not their fault, nor does it mean they are lousy drivers, they just have no experience. Such may be the case when your employees retire having never learned how to “drive” their own retirement plan.
Another concern that I have with financial illiteracy is based upon the fact that someday people may leave your plan, roll their money into other accounts, and have to rely “solely on the kindness of strangers.” As evidenced by Bernie Madoff and many other lesser-known felons, your employees will need to be somewhat sophisticated and prepared to at least be able to ask the right questions before signing away their retirement. With the average person staying in a job for 3.7 years, are they likely to recognize the value of their plan and roll it into another qualified plan, or take a distribution — despite the 20 percent withholding and 10 percent penalty — and purchase a much-needed flat screen TV?
Stress With a Capital $
Beginning in the fall of 2008, investors experienced a financial horror show. World stock markets tumbled, the housing crisis resulted in the lost of billions of dollars in home equity, Wall Street stumbled, and financial institutions crumbled. During that period of time, the average 401(k) lost approximately 30 percent. For the younger workers with a long time horizon to make up the losses, it would prove less impactful. For those near retirement however, it forced many people to add years to a prospective retirement date. Retirees also witnessed their investment income shrink forcing them to sometimes make difficult and painful decisions.
Financial stress is one of the leading causes of marital problems, and recently children of long-term out of work or underemployed adults have been diagnosed with a form of post traumatic stress symptom. With home prices down and average of 20 percent and 10 percent unemployment (and the potential of a job-less recovery), the impact of the “Great Recession” may be felt for years to come.
If your firm was forced to close facilities and downsized, then you personally have a good sense of the impact on individuals, communities and local economies. Stores closed, car dealers went bankrupt as the credit crunch touched many of us. For those who still had jobs, the sense was to hold on, and hunker down. As a result for the first time in decades, the savings rates increased as people became leery of spending for fear they could be next. This was not a case of people waking up and channeling the financial literacy part of their consciousness; it was more basic. It was a strategy for survival. Ironically in good times, an increase in the savings rates would have been applauded, yet in this economy, people were being encouraged to spend and stimulate the economy.
There are several lights on the horizon. First, as David Wray, President of PSCA has noted, the retirement system may have saved America from a depression. The fact is most people continued to save in their retirement plans throughout the past year and that action in itself may have bolstered the financial markets. Secondly, when you do the analysis, the fact is that despite the severe drop in account balances most participants didn’t lose their personal contributions — in reality the losses represented company matches and compounded earnings. It may not make it hurt any less for most of us, but if one were to better understand the nature of volatility, then our personal perspective may not have led us to jumping off the edge.
Another piece of good news surfaced in early December, when Vanguard released a study that reported that those who have suffered losses in the retirement plan from the fall of 2008 may have seen their account balances back to pre-loss levels. The study indicated that the younger employees who have taken advantage of maximizing the company match were more likely to recover in the shorter term. The concepts of dollar-cost averaging and compounding are important drivers of account growth and will help any participant get the most out of their contribution over the long term.
Part of stress is caused by the fear of the unknown. Unfortunately, we should not have been so unprepared. For two decades, dedicated HR/Benefit staffs along with retirement education specialists have conducted tens of thousands of meetings in cafeterias, conference rooms, and even loading docks. They spoke eloquently about market volatility and cited statistics to show that on any given year every investment has the potential to go up — and down. They tried to warn people about the need to diversify, that having the right asset allocation is more important than choosing individual funds, and that a market correction is not only a possibility but over time a probability.
What Can You Do As a Plan Sponsor For Your Employees?
Financial literacy could and should play a larger role in helping retirement investors have a better comprehension of those macro and micro economic factors that will positively or negatively impact their own retirement portfolio. Retirement education in many ways has become a commodity and is often looked upon as an expensive “nice to have,” rather than a “need to have.”
There are several things that Plan Sponsors can begin doing today.
1. Take a Holistic View
Work with your provider on expanding the traditional retirement education curriculum to include topics such as living on a budget. Coming in every year to your site and delivering the same information in the same way about your plan is not helping. Your employees are not listening and even for those who do, the impact is limited. Begin focusing on the bigger picture, target the employees’ families, make the financial education more inclusive — and consider including it at company picnics and benefit fairs.
2. Get Involved with Community Efforts
Investigate if the schools in your town have a financial literacy program, perhaps the local bank offers a workshop. Seek professionals and organizations in the areas where your employee lives to provide resources or other support materials that can be offered to your employees. Don’t make the story one-dimensional, the story is about financial well being, not simply saving for retirement.
3. Adopt Adult Learning Theory
One of the basics of adult learning theory is that adults will only listen and learn if the material is relevant. Ask yourself, when you were 25 years old, was the concept of retirement relevant to you? For your younger employees, don’t emphasize working all your life in the hope that 30 – 40 years in the future you may be able to enjoy a life in retirement. In our world of instant gratification, this story line doesn’t work. Instead, emphasize that having a good balance may enable the participant to get a loan to make a down payment on a house.
For workers in their 40s and 50s, the key message is to have them create a 10-year plan. The first step is to create and live on a budget. The second step is to pay off credit cards. Programs are available that you can adapt for your employees. Or, ask your provider to develop one for your company.
It would be interesting to do a baseline study to determine where your employee population is in regard to financial literacy. This would help the plan sponsor create a better overall retirement education program. A survey could take the shape of a simple test of 20 questions which could be created with the help of your provider. The easiest employee population to test would be new employees, who are more accustomed to pre-hire forms and testing.
The question is why should a plan sponsor care about the financial literacy of employees? Of course, the altruistic answers come first to mind although the age of the patriarchal employer taking care of their employees is long gone. In my opinion, there are two reasons that financial literacy programs should be integrated into retirement education. First, it is the right thing to do. It will help your employees make the best financial decisions about their life and help them in their retirement planning. The second reason is that in the age of employee vs. employer litigation, it may serve to mitigate claims that the company didn’t provide adequate information or education about an employee’s retirement plan and its investment options.
In Summary
Retirement education and financial literacy should go hand-in-hand. We can’t rely on our educational institutions to teach future generations everything they need to know to survive and prosper. As parents we also fall short on having the “financial birds and the bees” talks with our children. The point is not to look backward, but to look forward and make financial literacy a new best practice in retirement education.
Bob Benish has worked in participant and retirement education for over 25 years at several large mutual fund and insurance companies as well as heading up The Retirement Center. He is the author of the online high school program, Fin Lit 101, and has been referenced in the media as the “Dean” of Retirement Education.