Retirement decisions affect how we will live for the last third of our life. A firm foundation in reading and mathematics is essential for providing us with the tools that we need to make sound financial decisions later. Deciding to invest in higher education is one of the most important decisions of our lives and will prepare us for making wise financial choices. With this foundation in place, financial literacy education can help to ensure these sound financial choices.
Exposure to financial literacy education right before a financial decision is made has been shown to have the best success at improving financial outcomes. Our employers are best suited to provide this training when we need to make retirement plan choices. They, or their providers, offer us retirement savings plans and they know the reasons why tax deferred savings make sense. They know all of the plan features, options and investments. They know when financial decisions are needed and can provide education just before retirement plan decisions need to be made.
Employers have many reasons to provide financial literacy education. In my opinion, two of the most important reasons are:
1. Retirement plans are put in place by companies to attract, motivate, retain and reward employees. If employees don’t understand the plan and how to use it to their best advantage, they won’t appreciate it and employers may be wasting their money.
2. Employers want a natural flow of older employees voluntarily retiring and being replaced by younger, less costly and technologically advanced employees. If older employees have not saved enough to voluntarily retire, they just won’t retire.
There is a wide range of financial literacy education for retirement plans. The least effective is for an employer to provide employees with a booklet (summary plan description) and a prospectus describing the investment choices. The most effective is to provide each employee with an annual financial counseling meeting. Most employers provide education somewhere in the middle.
Many employers that don’t provide adequate financial literacy education for their retirement plans make automatic decisions for their employees. For example:
1. Automatically enroll employees in the plan with the opportunity to opt out.
2. Automatically deduct contributions from employee’s pay check (e.g. 3% of pay) and contribute to the plan. Employees would have the option to reduce or eliminate their contributions to the plan.
3. Automatically invest in a fund based on an employee’s age that will be aggressive at early ages and more conservative at later ages (lifestyle funds).
While the employer’s intent is good and the results are better than providing employees with the minimum required training and education, the results are not ideal. In many cases:
1. Employers don’t set the automatic contribution level high enough. The combined contributions for the employee and the employer need to be in the 12% to 15% range to accumulate sufficient assets (higher for employees who start saving at and older age.) As said before, employees won’t retire if they can’t afford to.
2. As seen during the last 10 years, lifestyle funds are not conservative enough for older employees who are approaching retirement. A large drop in the stock market just before retirement could make them postpone retirement 5 years or more.
I believe that employers should provide a combination of some automatic features as well as adequate financial literacy education. The objective should be to train employees to contribute enough and invest well enough to voluntarily retire at a reasonable retirement age. Providing personal, annual retirement consulting services for each employee would be ideal but cost prohibitive for almost all employers. Alternatively, employers could provide annual employee education that includes their use of a financial calculator that shows what their retirement income would be and how long that it would last based on how much they contribute and several other assumptions. Topics in the education should include:
1. How much do I need to contribute?
2. How should I invest and what is my risk tolerance?
3. What will Social Security provide?
4. What does Medicare provide and not provide?
5. How much will I need for medical, dental, vision and hearing related premiums, costs and co-payments?
6. Do I need Long Term Care insurance?
7. How will I take distributions from the plan?
8. Do annuities make sense?