Retirement insights from a Colorado PERA perspective

A distant view shows a mountainous landscape with sloping peaks, green trees in the foreground, and a cloudy sky above.

News You Should Know is a digest of news from publications around the nation about finance, investing, and retirement.



<a rel="noreferrer noopener" href="https://www.cnbc.com/2020/09/28/want-to-be-better-investor-through-the-pandemic-manage-your-emotions.html" target="_blank">Here’s how to manage your emotions while investing through the pandemic</a> | CNBC



The human brain doesn’t always compute reality correctly. Researchers call these hiccups in judgment “cognitive biases.” An entire field of economics, called behavioral economics, is built around how our cognitive biases affect financial decisions. In this article, financial advisors identify which cognitive biases they see their clients most easily influenced by. To learn more about the top 5, click on the links below: 



<ul><li><a href="https://www.copera.org/what-would-your-financial-advisor-say-about-you" target="_blank" rel="noreferrer noopener" class="broken_link">Recency bias</a> (35%)</li><li><a href="https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/loss-aversion/" target="_blank" rel="noreferrer noopener">Loss aversion</a> (30%)</li><li><a href="https://www.investopedia.com/terms/h/homebias.asp" target="_blank" rel="noreferrer noopener">Home bias</a> (27%)</li><li><a href="https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/mental-accounting/" target="_blank" rel="noreferrer noopener">Mental accounting</a> (26%)</li><li><a href="https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/framing-effect/" target="_blank" rel="noreferrer noopener">Framing</a> (26%)</li></ul>



While nobody can avoid being completely unbiased all the time, we can become aware of where we are most prone to misunderstanding.



<a rel="noreferrer noopener" href="https://www.healthcarefinancenews.com/news/public-sentiment-healthcare-deteriorating-during-covid-19-pandemic" target="_blank">Public sentiment on healthcare deteriorating during COVID-19 pandemic</a> | Healthcarefinancenews.com



Americans have shown appreciation for health care workers since March. But that doesn’t mean they like the health care system any better. According to a recent survey, one-third of respondents said they like the U.S. healthcare system less now than they did before the pandemic. Other trends this story covers include an uptick in <a href="https://www.copera.org/what-would-your-financial-advisor-say-about-you" target="_blank" rel="noreferrer noopener" class="broken_link">virtual care</a> and a reluctance to change jobs due to health insurance.



<a rel="noreferrer noopener" href="https://www.ft.com/content/84ffa0db-3a77-4944-85fc-ce39c7a83d22" target="_blank">When are you going to retire?</a> | FT



People in a defined benefit plan know ahead of time what their lifetime monthly income will be. Those with a defined contribution account must do a little more math, determining how their nest egg will translate into income. One oft-used rule of thumb is the 4% rule, which states a person can safely withdraw 4% of their savings per year. This article updates that advice and outlines a few more complexities to consider.



<a href="https://www.kiplinger.com/retirement/601366/10-things-youll-spend-more-on-in-retirement" target="_blank" rel="noreferrer noopener">10 Things You’ll Spend More on in Retirement</a> | Kiplinger



When sketching out your expected retirement bills, you might already be penciling in more for health care expenses. But what about a higher gas bill? And with all that extra free time, will you be more susceptible to shopping trips (and yes, shopping online counts). This list will help keep you honest with your budget.

What Would Your Financial Advisor Say About You?

Maybe you’re an executive involved in a major business deal; the director of high-profile agency facing a public crisis; the surgeon staring down at a critical patient. But what if the deal goes bust? What if there’s a public outcry over your performance? What if the patient has already died?



Take a step back from that hypothetical worst-case scenario and figure out what went wrong – and why. That’s what’s called the “pre-mortem.”



The <a href="https://hbr.org/2007/09/performing-a-project-premortem" target="_blank" rel="noreferrer noopener">pre-mortem</a> is a powerful tool for ensuring a project succeeds by identifying ahead of time possible pitfalls. Whether it’s imagining how an emergency surgery could go wrong, playing out where a department merger could encounter obstacles, or anticipating when a retirement account could no longer meet expenses, thinking through the challenges that any future plans might face can help to avert them – or at least create preparation if they come true.



According to cognitive psychologist and pre-mortem inventor Gary Klein, a pre-mortem can <a href="http://www.theguardian.com/lifeandstyle/2014/may/10/hindsight-in-advance-premortem-this-column-change-life" target="_blank" rel="noreferrer noopener">take the pressure off</a> of anyone worried about seeming disloyal to a group by voicing concerns, and <a href="http://www.theguardian.com/lifeandstyle/2014/may/10/hindsight-in-advance-premortem-this-column-change-life" target="_blank" rel="noreferrer noopener">generate spirited competition</a> to find new reasons for a project’s potential failure.



Business has been quick to adopt the practice of a pre-mortem for new projects, but performing a pre-mortem also has application as a retirement planning tool. Retirement planning can stir a range of emotions, from anxiety to anger to paralysis. In a successful pre-mortem, we take our heads out of the sand and go right into the belly of the beast as we face head-on our fears related to retirement.



It takes just <a href="http://www.riskology.co/pre-mortem-technique/" target="_blank" rel="noreferrer noopener">three easy steps</a> to perform a pre-mortem. Begin the exercise with critical stakeholders such as your spouse in the room. List everything that can go wrong in retirement. Be exhaustive and catastrophic. No possibility is too horrifying. At a minimum, start the exercise by considering a state of advanced age, poverty, and ill health. Scenarios might include income not covering current expenses. Your emergency fund has been depleted. You are living with your children, in a state of failing health. Just get ideas on the table, no matter how absurd. At this stage when everyone is brainstorming, there should be no moving on to problem solving.



Next step: pick the 10 worst outcomes. Focus on problems that, if not solved, will mean true catastrophe. Discard events over which you have no control. Instead, pick events most likely to happen. If you are on track to pay off your mortgage by retirement, a foreclosure on your home shouldn’t make the list, but you’ll still need income to pay property taxes, insurance, utilities, and maintenance.



Finally, devote time to thinking up solutions. Insufficient income can be checked by saving more today, or retiring later with a larger amount from Social Security or a pension. Health concerns can be addressed now with preventive screenings, diet, and exercise. A life insurance policy may be in order for burial expenses or for a surviving spouse or children. Also outline plan B if plan A can’t be obtained. Because the exercise involves all stakeholders, hold each other accountable for the action items identified. Break items into smaller steps, assign tasks, and stick to agreed upon deadlines. The exercise is useless if inertia carries the day.



The pre-mortem should generate actionable items today that, if implemented, prevent the worst from happening. Placing yourself in a future catastrophic financial situation also combats the tendency to discount the importance of future events for more immediate ones. Go ahead. If the glass isn’t at least half empty, the exercise won’t be a success.

How to run out of money successfully: Conduct a retirement pre-mortem

When looking for answers about the savings crisis in America, look to loss aversion, the idea that we <a href="https://www.youtube.com/watch?v=642kB411kRc" target="_blank" rel="noreferrer noopener">“hate losing more than [we] even want to win.”</a> Loss aversion has a profound effect on retirement security, and it deserves our attention.



Americans aren’t saving enough, in part because we see a paycheck deduction and think of it as a <a href="https://www.copera.org/loss-aversion-the-pain-of-parting" target="_blank" rel="noreferrer noopener" class="broken_link">loss</a>, rather than as a future payoff. According to <a href="https://www.copera.org/nobel-prize-puts-spotlight-on-behavioral-economics-retirement-plan-policy" class="broken_link">behavioral finance pioneers</a>, people experience a <a href="https://www.copera.org/loss-aversion-the-pain-of-parting" target="_blank" rel="noreferrer noopener" class="broken_link">greater sensitivity to a decrease</a> in wealth than they do to an increase of the same amount. Choosing not to enroll in, or to underfund, one’s retirement plan is a way of avoiding the feeling of having to give up something. Unfortunately, the tradeoff is retirement security. That is, unless an employer makes retirement plan participation mandatory, as is the case with Colorado PERA’s defined benefit plan.



Luckily, the PERA defined benefit plan will <a href="https://www.copera.org/fordham-institute-gets-wrong" class="broken_link">comprise participants’ core income in retirement</a>, proportionate to the years spent contributing. However, everyone agrees that individual savings are a key factor in boosting retirement security. When a participant postpones opening or underfunds a supplemental plan, loss aversion is at play. But the effects of loss aversion can be mitigated to some degree with mandatory participation.



The Endowment Effect



<blockquote class="wp-block-quote">
A core feature of loss aversion is the endowment effect. Simply put, individuals place greater value on things they already own compared to items they have yet to obtain. Some experiments show that this value placed on things already owned can be as much as twofold.
</blockquote>



Implications of the endowment effect come in several forms. If well-intentioned savers set up a savings plan without realizing how high its fees are, the endowment effect leaves them in danger of staying, even when they realize high fees are eating away at their balances. Similarly, the endowment effect also explains why investors may be <a href="http://time.com/money/3853922/richard-thaler-behavioral-economics-cashews/?iid=sr-link1" target="_blank" rel="noreferrer noopener">unwilling</a> to part with underperforming or high-cost investments simply because they already own them.



As a low-cost provider in both its defined benefit plan and defined contribution plans, Colorado PERA helps its members avoid these concerns. PERA’s defined benefit plan operates at $51 per member per year, <a href="https://www.copera.org/loss-aversion-the-pain-of-parting" class="broken_link">$9 below the average among its peers</a>. The PERA hybrid defined benefit plan provides <a href="https://content.copera.org/loss-aversion-the-pain-of-parting/">more retirement security</a> to its members at a lower cost than other plan designs.



Colorado PERA’s defined contribution plans also offer a low-cost option (and peace of mind about fees) for individuals who wish to manage their own mandatory contribution, or set up a supplemental account in the form of the PERAPlus 401(k) or 457 Plan.



These low-cost defined contribution plans have expert advice tools built in at no additional charge, and are designed to help a participant avoid making bad investment decisions. Participants can set up and follow an asset allocation strategy or choose a target retirement date fund that offers a hedge against mistakes participants might make if they were to pick individual stocks or pay for advice.



Furthermore, Colorado PERA’s defined benefit investment portfolio is guided by an <a href="https://www.copera.org/good-governance-is-standard-practice-for-colorado-pera" target="_blank" rel="noreferrer noopener" class="broken_link">asset allocation strategy</a> set by the Board of Trustees. Investment decisions are informed by that strategy and executed by a team of experts who weigh the risk and return tradeoffs of a diverse universe of investments.



As long as individuals make financial decisions that seek to avoid loss even if it means a future gain, defined benefit plans, where participation is required, will be a successful avenue to retirement security.

Loss Aversion: The Pain of Parting

What do a diamond, the UN, and preparing for retirement have in common?&nbsp;They are all examples of when rational thought has been hijacked by a process known as anchoring. The field of <a href="http://www.investopedia.com/university/behavioral_finance/" target="_blank" rel="noreferrer noopener">Behavioral Finance</a> has chronicled the power of anchoring since the 1970s. Anchoring leads otherwise reasonable people to make irrational decisions that can result in their financial detriment. The danger is best explained by the situations described below.



Diamonds



The conventional wisdom has people spending two months’ pay for an engagement ring. If a potential newlywed makes $50,000 a year, by the two months’ pay rule, the ring should cost $8,300! For anyone living paycheck to paycheck (most of us), this is an unreasonable if not irrational amount to spend on an engagement ring. This mental shortcut anchors the decision-making of potential newlyweds into spending much more than they might be able to afford, especially when <a href="http://www.plansponsor.com/Majority-in-US-Have-Less-Than-a-Grand-Saved/" target="_blank" rel="noreferrer noopener">research shows</a> most Americans have less than $1,000 in savings.



Two months’ pay for a ring has no basis in responsible financial behavior; in fact, it was part of an <a href="http://blog.hubspot.com/marketing/diamond-de-beers-marketing-campaign" target="_blank" rel="noreferrer noopener">ad campaign</a> by the De Beers mining company to increase diamond sales.



The United Nations



Behavioral economists Daniel Kahneman and Amos Tversky were the first to illustrate the power of anchoring in decision-making. In 1974, <a href="https://www.copera.org/diamonds-the-united-nations-and-retirement-planning" target="_blank" rel="noreferrer noopener" class="broken_link">experiment</a> subjects were asked to estimate the percentage of African countries represented in the United Nations in relation to a number spun on a wheel. When participants spun a 10, the median estimate was 25 percent; when they spun a 65, the estimate went to 45 percent. This example demonstrates that people determine a value based on a preconceived baseline and then adjust away from it by anchoring on the original amount.



Retirement Plans



Anchoring can also undermine your retirement savings when it comes to choosing how much to save. Many employer defined contribution plans have set up auto enrollment, but anchored the <a href="http://time.com/money/3853922/richard-thaler-behavioral-economics-cashews/" target="_blank" rel="noreferrer noopener">default rate too low</a> at 3 percent. Regardless of the <a href="https://www.copera.org/diamonds-the-united-nations-and-retirement-planning" target="_blank" rel="noreferrer noopener" class="broken_link">default savings rate</a>, plan participants anchor to it in overwhelming numbers. With or without auto enrollment, other anchors include saving the minimum, the maximum, as much as the match, or what <a href="https://www.copera.org/diamonds-the-united-nations-and-retirement-planning" target="_blank" rel="noreferrer noopener" class="broken_link">coworkers</a> do.



None of these shortcuts in decision-making inform how much someone would need to save to reach a financial goal in retirement. The decision errors are understandable. Estimating retirement savings is a complex task, and easily <a href="https://www.copera.org/diamonds-the-united-nations-and-retirement-planning" target="_blank" rel="noreferrer noopener" class="broken_link">pushes beyond</a> the limits of nearly all savers’ expertise.



Anchoring occurs when, one way or another, we have a preconceived starting point when trying to calculate how to move forward. This could be that a diamond ring ought to be worth two months’ salary. Or it could be that 3 percent of every paycheck is a good place to begin saving for retirement. And, unfortunately, even if we have been warned about anchoring, it still happens.



<blockquote class="wp-block-quote">
The best guard against anchoring is an awareness of when we step outside the limits of rational decision-making. Outside those limits we are most vulnerable to anchors that are sinking our retirement accounts.
</blockquote>



For defined benefit plan participants decisions are streamlined, and stay within reasonable boundaries of knowledge. The shift to defined contribution plans over the years has added complexity without a corresponding increase in expertise from plan participants, leaving everyone vulnerable to insufficient savings in retirement.



PERA’s Defined Contribution Plan and voluntary 401(k) and 457 plans include advice tools (at no additional cost) which help inform how much to save to reach a certain goal and what funds to consider given a participant’s risk tolerance and investment time horizon. Advice tools go a long way toward restructuring decision-making from irrational and reflexive back to rational and deliberate – and can help eliminate the problems associated with anchoring.

Diamonds, the United Nations, and Retirement Planning

The <a href="https://www.copera.org/ten-things-to-know-before-you-retire" target="_blank" rel="noopener noreferrer" class="broken_link">Denver Post</a>, <a href="http://www.forbes.com/sites/fross/2015/01/12/5-retirement-resolutions-for-2015/" target="_blank" rel="noopener noreferrer">Forbes</a> magazine, <a href="http://www.dol.gov/ebsa/publications/10_ways_to_prepare.html" target="_blank" rel="noopener noreferrer">U.S. Department of Labor</a>, and the <a href="https://content.copera.org/ten-things-to-know-before-you-retire/" target="_blank" rel="noopener noreferrer">Center for Retirement Research at Boston College</a> all provide lists of things to think about to best prepare for retirement.
So what should the “average person” know and do to prepare for retirement? A quick search of the Internet alerts readers to countless prescriptions for retirement planning. These <a href="https://www.google.com/?gws_rd=ssl#q=how+to+prepare+for+retirement" target="_blank" rel="noopener noreferrer">articles</a> have distilled the retirement preparation process into a number of “easy” steps. Like with a medical prescription, when it comes to retirement preparation, following the label instructions through the full course of treatment – until and into retirement – is most likely to ensure a satisfactory outcome.
Here’s the PERA on the Issues list of steps to take to prepare for retirement:
Step 1. Define your retirement dreams. From simple to exotic, retirement dreams come in all shapes and sizes. For some, spending retirement at home with children and grandchildren or volunteering in the community may be just what the doctor ordered. For others, retirement may mean starting a new career, perhaps at a different pace. Or maybe sailing off and settling in a South Pacific paradise? The importance of defining life after work is the first step.
Step 2. Look at the price tag. Here’s where the balance sheet begins. How much will it cost? Not much is going to be free, but some items may be discounted. Most people want to take advantage of discounts wherever possible. That may make more dreams possible to be fulfilled. At a fundamental level, <a href="https://www.copera.org/ten-things-to-know-before-you-retire" target="_blank" rel="noopener noreferrer" class="broken_link">is retirement even possible</a>? The Employee Benefit Research Institute’s <a href="https://www.copera.org/ten-things-to-know-before-you-retire" target="_blank" rel="noopener noreferrer" class="broken_link">2015 Retirement Confidence Index</a> reports workers’ increasing confidence in their ability to pay for retirement, including an 8 percent jump in those who are very confident in their ability to pay for basic expenses (up from 29 percent in 2014), a 6 percent increase in those very confident in their ability to pay for medical expenses (up from 12 percent in 2011), and a 5 percent increase in those very confident they will be able to pay for long-term care expenses (up from 9 percent in 2011).
Step 3. Find the discounts. Prices are one thing, but being creative can reduce the cost of retirement. What <a href="http://www.nolo.com/legal-encyclopedia/top-tax-deductions-seniors-retirees-29591.html" target="_blank" rel="noopener noreferrer">tax breaks</a>, exemptions, and exclusions are available? In Colorado, retirees benefit from <a href="https://www.copera.org/pera-on-the-issues/ten-things-to-know-before-you-retire" target="_blank" rel="noopener noreferrer">pension income exclusions</a> up to certain levels and age restrictions. In addition, Colorado has provisions for a <a href="https://www.copera.org/ten-things-to-know-before-you-retire" target="_blank" rel="noopener noreferrer" class="broken_link">Homestead Exemption</a> and certain <a href="https://www.copera.org/ten-things-to-know-before-you-retire" target="_blank" rel="noopener noreferrer" class="broken_link">senior tax work-off</a> programs that may reduce property taxes. How about <a href="http://www.aarp.org/home-garden/transportation/info-05-2010/auto_insurance_discounts.html" target="_blank" rel="noopener noreferrer">auto</a> and home insurance discounts? Ever think about forming an informal purchasing cooperative with friends or neighbors to divide up a large quantity of commonly used items? Are there more advantageous times during the year to make certain purchases or to book a vacation or cruise?
Step 4. Add it up. Sum up resources and debts. Social Security, retirement plans, tax-deferred accounts (401(k), 403(b), 457, IRAs), Roth accounts, personal investments, and savings need to be assessed. What kind of debt such as a mortgage, a car, or child college expenses are on the other side of the balance sheet?
Step 5. Build a realistic plan. Designing a plan is both the easiest and the hardest task all at the same time. Be realistic and stay on track. The plan should put lifestyle and resources in context. This may involve making decisions and choices and building priorities. Developing a budget is a fundamental step in fitting all of the “to-do” list items into the available resources. Some expenses in retirement will completely go away or be reduced (such as a work wardrobe) and other expenses (like health care) will increase.
Step 6. Do a financial and lifestyle dry run. Lots of financial planning advice has included taking the plan and implementing some of its components before retirement actually takes place. Is it affordable? Are these activities enjoyable? Perhaps now is the time to have a reality check.
Step 7. Think about what can get in the way. Temporary or permanent changes can and likely will happen at some point in retirement. Medical, family, and financial issues can occur at almost any point. Preparation is the key. Having a contingency plan is mandatory. Medical history may be a good indicator of good and bad things to come. Aging parents and their need for care may interrupt best laid plans. Financial resource protection must be monitored and modified based upon economic cycles.
Step 8. Get some advice. While many like to “go it alone,” some well-placed counsel can answer a lot of very practical questions about every aspect of retirement from financial advice to “happening” things to do in the community. Certainly, the advice from a qualified and trusted financial advisor can identify all sorts of tax-saving strategies and investment products designed for retiree wealth protection. But remember, buyer beware.
Step 9. Get ready to do it. Retirement preparation includes wrapping up current business affairs and staging the next chapter. Just like the hand-off in a football game, in an employment situation, the critical component to success is preparing to give the ball to someone else. Executing this well can be the capstone of a rewarding career and build the foundation for the future success of the organization you leave.
Step 10. Periodically review and possibly revise the plan. Robert Burns said it so well in his 1786 poem, To a Mouse:
In proving foresight may be vain: 
The best laid schemes o’ mice an’ men 
Gang aft a-gley, [often go awry].
Retirement preparation includes the foreknowledge that any plan must be flexible to adjust to new realities. Health, investment return, unforeseen bills, or loss of a spouse or partner might change the current picture.
After all, living life is the process of continuously adjusting. Thinking now about retirement and how to make it happen means it will be more likely to see a retirement dream as day-to-day life after retirement.

Ten Things to Know Before You Retire

A digest of timely information and insight about finance, investing, and retirement.



<a href="http://www.cbsnews.com/news/is-more-money-the-key-to-a-happy-retirement/" target="_blank" rel="noreferrer noopener">Is more money the key to a happy retirement?</a>&nbsp;|&nbsp;<a href="http://www.cbsnews.com" target="_blank" rel="noreferrer noopener">CBS News</a>



With many people approaching their retirement years with meager savings, aiming to be happy might be more realistic than aiming to fully retire and not work at all. But that means thinking about how much money you really need to be happy.



<a href="https://www.copera.org/retirement-roundup-is-more-money-the-key-to-a-happy-retirement" target="_blank" rel="noreferrer noopener" class="broken_link">Student debt repayment takes priority over retirement planning</a>&nbsp;|&nbsp;<a href="http://www.benefitnews.com" target="_blank" rel="noreferrer noopener">Employee Benefit News</a>



A recent report found that 68 percent of US millennials, those ages 20 to 37, are saving for retirement, about 48 percent of them in a workplace-sponsored 401(k) plan. Only 29 percent were actively preparing for retirement. Of millennials who were surveyed, 77 percent listed debt reduction as their top retirement strategy. The study also found that 28 percent of millennials believe they won’t be able to retire at the age they want and 28 percent don’t believe they will ever be able to retire. [See what <a href="http://www.thedimecolorado.com">The Dime</a> has to say about <a href="https://www.copera.org/retirement-roundup-is-more-money-the-key-to-a-happy-retirement" class="broken_link">student loans vs. saving for retirement</a>.]



<a href="https://www.copera.org/retirement-roundup-is-more-money-the-key-to-a-happy-retirement" target="_blank" rel="noreferrer noopener" class="broken_link">Auto-escalation on the rise in retirement plans</a>&nbsp;|&nbsp;<a href="http://www.benefitnews.com" target="_blank" rel="noreferrer noopener">Employee Benefit News</a>



The retirement industry is hopeful that Americans are beginning to save enough for a successful life post-employment, and auto-escalation plays a big part in such optimism. Auto escalation automatically increases the percentage of an employee’s salary that is contributed to a retirement plan. In the last 12 to 24 months, the move to have plans auto-escalate has picked up significantly.



<a href="http://www.bloomberg.com/news/articles/2015-09-16/senior-savers-will-wait-to-reap-benefits-from-fed-rate-increases" target="_blank" rel="noreferrer noopener">Senior savers will wait to reap benefits from fed rate increases</a>&nbsp;|&nbsp;<a href="http://www.bloomberg.com" target="_blank" rel="noreferrer noopener">Bloomberg</a>



After years of enduring meager returns on low-risk investments, retirees can look forward to more money in their pockets after the Fed starts raising interest rates, though the benefits won’t flow swiftly. The Fed, which has drawn political ire for policies that critics say penalized savers, says it expects to only raise rates gradually.



<a href="http://www.nytimes.com/2015/09/28/your-money/dealing-with-an-investing-blind-spot.html" target="_blank" rel="noreferrer noopener">Dealing with an investing blind spot</a>&nbsp;|&nbsp;<a href="http://www.nytimes.com" target="_blank" rel="noreferrer noopener">New York Times</a>



We all have blind spots, and it’s hard to be objective about our own behavior. A simple, though maybe not easy, solution is to find and listen to other people who can see our blind spots. [Read more about how <a href="https://www.copera.org/retirement-roundup-is-more-money-the-key-to-a-happy-retirement" class="broken_link">bad financial decisions can lead to trouble</a> when it comes to retirement savings.]



<a href="http://www.bankrate.com/finance/consumer-index/when-crisis-hits-older-americans-more-likely-to-raid-retirement-savings.aspx" target="_blank" rel="noreferrer noopener">When crisis hits, older Americans more likely to raid retirement savings</a>&nbsp;|&nbsp;<a href="http://www.bankrate.com" target="_blank" rel="noreferrer noopener">Bankrate</a>



One in 8 Americans tapped their retirement savings over the past 12 months to pay for a household emergency, according to a September survey that accompanies the Bankrate Financial Security Index. The chances of people using retirement savings go up with age, with 8 percent of those between ages 18 and 29 saying they had done so, compared to 19 percent of people at least 65 years old. [<a href="https://www.copera.org/retirement-roundup-is-more-money-the-key-to-a-happy-retirement" class="broken_link">Our ancestors may be to blame</a> for why we spend our retirement savings today instead of saving for when we’ll need it.]

Retirement Roundup: Is More Money the Key to a Happy Retirement?

Colorado PERA takes a holistic approach to retirement



The future seems hopeless to me and I can&#8217;t believe that things are changing for the better.



I am satisfied with my present financial situation.



Is either sentiment relevant to financial literacy? The U.S. Social Security Administration’s Office of Retirement and Disability Policy studied <a href="http://www.ssa.gov/policy/docs/ssb/v73n1/v73n1p73.html" target="_blank" rel="noreferrer noopener">Psychosocial Factors and Financial Literacy</a> and found a positive correlation between financial satisfaction and financial literacy (but a negative correlation with hopelessness). Perhaps most relevant to Colorado PERA and its members is the study’s finding that while financial literacy is essential to retirement planning and readiness, most Americans do not have adequate knowledge and understanding of financial matters.



(Eduardo Porter of The New York Times makes a similar argument, as discussed in an <a href="https://www.copera.org/retirement-roundup-is-more-money-the-key-to-a-happy-retirement" class="broken_link">earlier PERA on the Issues</a> post.)



The University of Michigan Health and Retirement Study (<a href="http://hrsonline.isr.umich.edu/" target="_blank" rel="noreferrer noopener" class="broken_link">HRS</a>), a longitudinal study that surveys 20,000 Americans over the age of 50 every two years, asked,



“Let’s say you have $200 in a savings account. The account earns 10 percent interest per year. How much would you have in the account at the end of two years?”



Tellingly, Annamaria Lusardi, in <a href="https://www.copera.org/financial-literacy-retirement-planning-and-hopelessness" target="_blank" rel="noreferrer noopener" class="broken_link">Planning for Retirement: The Importance of Financial Literacy</a>, reported that only 18 percent of respondents correctly computed the compound interest question. And these are Americans over the age of 50 who have presumably made important financial decisions throughout their lifetimes, including opening checking accounts, applying for mortgages, and saving for retirement.



As Lusardi observes in <a href="http://www.finrafoundation.org/web/groups/foundation/@foundation/documents/foundation/p240590.pdf" target="_blank" rel="noreferrer noopener" class="broken_link">FLAT World</a> (Financial Literacy Around the World):



<blockquote class="wp-block-quote">
Across the world, people are being asked to assume more responsibility for their financial well-being. Because of changes in the pension landscape, notably a shift from defined benefit to defined contribution type pensions, individuals must determine not only how much to save for retirement but also how to allocate that retirement wealth. This responsibility is paired with financial instruments that are increasingly complex.
</blockquote>



According to Lusardi, financial literacy is linked to retirement planning and those who are more knowledgeable about financial matters are more likely to plan for retirement. This means financial literacy affects retirement planning and retirement planning leads to retirement security. Ted Beck, President and CEO of the <a href="http://www.nefe.org/" target="_blank" rel="noreferrer noopener">National Endowment for Financial Education</a>, a nonprofit organization providing financial education resources at all financial stages, asserts that the retention rate for financial lessons learned among adults is less than two years. He argues that adults need “boosters” to maintain knowledge. Having practical information readily available is essential for adults to make informed decisions on financial matters.



The Federal Reserve studied the effect of financial literacy efforts on consumer behavior (<a href="http://www.federalreserve.gov/pubs/bulletin/2002/1102lead.pdf" target="_blank" rel="noreferrer noopener">Financial Literacy: An Overview of Practice, Research, and Policy</a>) and found borrowers who had received individual counseling had a 34 percent lower delinquency rate than those who received no counseling. Additionally, those receiving financial training had increased average monthly net deposits with each additional hour of training (up to 12 hours). Workplace training programs are also an effective way to increase participation in 401(k) plans according to the study, with a significant positive relationship between financial education and the total savings rate.



Here in Colorado, there are several initiatives underway to increase financial literacy and provide for retirement security. PERA recently partnered with the <a href="https://www.copera.org/financial-literacy-retirement-planning-and-hopelessness" target="_blank" rel="noreferrer noopener" class="broken_link">Colorado Jump$tart Coalition</a>, a nonprofit organization dedicated to improving the personal financial literacy of Colorado youth by “teaching the teachers” about their own personal financial situations through professional development opportunities. The last two Colorado legislative sessions have also seen <a href="http://www.leg.state.co.us/CLICS/CLICS2015A/csl.nsf/fsbillcont3/9167FC78AD7F7B7787257DC40082EF65?Open&amp;file=1235_ren.pdf" target="_blank" rel="noreferrer noopener">bills</a> proposed to study, assess, and report on the factors that affect Coloradans’ ability to save for a financially secure retirement.



In addition to providing its members with a <a href="https://www.copera.org/members/retirement-benefits" target="_blank" rel="noreferrer noopener">hybrid defined benefit plan</a>, PERA also encourages its members to supplement their savings with several <a href="https://www.copera.org/women-face-unique-challenges-in-retirement" target="_blank" rel="noreferrer noopener" class="broken_link">voluntary retirement plans</a>, including a low-cost 401(k) plan. And to help members become more informed about personal financial issues, <a href="http://www.thedimecolorado.com/" target="_blank" rel="noreferrer noopener">The Dime</a> contains information on topics relevant to public employees busy balancing work and family. By <a href="https://content.copera.org/are-public-sector-workers-satisfied/" target="_blank" rel="noreferrer noopener">educating members</a> on retirement planning and supporting their financial literacy, PERA hopes to ensure members feel in control of their financial future and will be able to answer in the affirmative if asked if they are satisfied with their present financial situation.



How did you answer the financial literacy question posed earlier in this article?



“Let’s say you have $200 in a savings account. The account earns 10 percent interest per year. How much would you have in the account at the end of two years?”



If you said $242, give yourself an A!

Financial Literacy, Retirement Planning, and Hopelessness

A digest of timely information and insight about finance, investing and retirement.



<a href="http://blogs.wsj.com/totalreturn/2015/05/28/states-tackle-americas-retirement-savings-shortfall/" target="_blank" rel="noreferrer noopener">States Tackle America’s Retirement-Savings Shortfall</a>&nbsp;|&nbsp;<a href="https://www.copera.org/retirement-roundup-best-articles-from-around-the-web" target="_blank" rel="noreferrer noopener" class="broken_link">Total Return Blog</a>, <a href="http://www.wsj.com">Wall Street Journal </a>State legislatures across the nation are looking for ways to encourage more Americans to save for retirement, in hopes of avoiding public assistance down the road for retirees with insufficient savings. With more than half of working Americans having no retirement coverage at work, the <a href="http://crr.bc.edu/special-projects/national-retirement-risk-index/" target="_blank" rel="noreferrer noopener">Center for Retirement Research at Boston College</a> “calculates that 53% of working-age households are at risk of being unable to maintain their pre-retirement standard of living” in retirement.



<a href="http://www.plansponsor.com/Generation-X-Most-at-Risk-Financially/" target="_blank" rel="noreferrer noopener">Generation X Most at Risk Financially</a>&nbsp;|&nbsp;<a href="http://www.plansponsor.com/" target="_blank" rel="noreferrer noopener">PlanSponsor </a>As a generation, Gen Xers (ages 35 to 49) have the poorest financial habits according to a new study of Americans that looked at financial planning and savings. With more “spenders” than “savers” compared to other generations, 37 percent of Gen X adults “do not at all feel financially secure” and 18 percent believe they will never retire.



<a href="http://squaredawayblog.bc.edu/squared-away/rewriting-the-american-dream/" target="_blank" rel="noreferrer noopener">Rewriting the American Dream</a>&nbsp;|&nbsp;<a href="http://squaredawayblog.bc.edu/" target="_blank" rel="noreferrer noopener">Squared Away Blog</a>, <a href="http://crr.bc.edu/" target="_blank" rel="noreferrer noopener">Center for Retirement Research at Boston College </a>Having enough money in the bank to retire is the top indicator of financial success, according to 28 percent of U.S. adults in a survey sponsored by the American Institute of CPAs. Sending kids to college without having to borrow to pay for it was second (23 percent) with homeownership and upward mobility each a distant third (11 percent).



<a href="https://www.copera.org/retirement-roundup-best-articles-from-around-the-web" target="_blank" rel="noreferrer noopener" class="broken_link">Pension program changes hurt economy, NCPERS report warns</a>&nbsp;|&nbsp;<a href="https://www.copera.org/federal-legislation-hurt-institutional-investors-main-street-retirees" target="_blank" rel="noreferrer noopener" class="broken_link">Pensions &amp; Investments </a>Shifting from defined benefit to defined contribution plans and other pension program changes might be widening the income gap and hindering economic growth, according to a new report from the National Conference on Public Employee Retirement Systems.

Retirement Roundup: Pension Program Changes Hurt Economy

Why do so many of us spend our retirement savings today instead of saving for when we’ll need it? The answer may come from our ancestors.



We’ve written before about how&nbsp;<a href="https://www.copera.org/doing-more-not-less-to-save-retirees-from-financial-ruin" target="_blank" rel="noreferrer noopener" class="broken_link">Americans aren’t doing enough to save for retirement.</a>&nbsp;“<a href="https://www.copera.org/robbing-from-ourselves-why-our-ancestry-may-be-to-blame" target="_blank" rel="noreferrer noopener" class="broken_link">Today’s workers face a major retirement income challenge</a>,” according to the Center for Retirement Research at Boston College.



So given the already&nbsp;<a href="http://crr.bc.edu/wp-content/uploads/2014/09/IB_14-151.pdf" target="_blank" rel="noreferrer noopener">fragile</a>&nbsp;state of American’s retirement savings, it’s obvious that if workers withdraw money from their retirement accounts for non-retirement purposes, they further compromise their retirement security.



To examine the impact of “leakage,” or the early withdrawal of retirement savings for non-retirement purposes, the&nbsp;<a href="http://www.ebri.org/" target="_blank" rel="noreferrer noopener">Employee Benefit Research Institute</a>&nbsp;(EBRI) conducted a series of simulations. The results confirm that taking money out of retirement savings for non-retirement purposes negatively impacts our ability to actually save enough for retirement.



In&nbsp;<a href="https://www.copera.org/robbing-from-ourselves-why-our-ancestry-may-be-to-blame" target="_blank" rel="noreferrer noopener" class="broken_link">testimony</a>&nbsp;to the ERISA Advisory Council of the U.S. Department of Labor in 2014, EBRI stressed that cash-outs, or taking cash out of a retirement plan when changing jobs, is the biggest concern, but loans and hardship withdrawals are problematic as well.



A 2013&nbsp;<a href="https://www.copera.org/robbing-from-ourselves-why-our-ancestry-may-be-to-blame" class="broken_link">study</a>&nbsp;by Hello Wallet estimates that each year $70 billion of the $293 billion contributed to retirement plans exits for non-retirement purposes.



According to&nbsp;<a href="https://www.copera.org/robbing-from-ourselves-why-our-ancestry-may-be-to-blame" target="_blank" rel="noreferrer noopener" class="broken_link">EBRI’s simulations</a>, leakage is a problem that affects lower income earners harder. Twenty percent of those in the lowest income quartile who would otherwise have an 80 percent real replacement rate will fall short due to cash-outs at job change.



Why would someone jeopardize having enough money saved for a secure retirement by prematurely taking money out of their retirement accounts? The same reason countless experiments in human behavior map out our preference for $50 today over $100 a year from now. A quick calculation of the time value of money tells us $100 next year is worth more than the $50 today, but human tendency is to assign greater value to something immediately accessible than something available down the road.



Known as temporal discounting, this behavior explains how otherwise sensible people might tap dollars in their retirement accounts. For many of us, fulfilling immediate needs with a cash reward today far outweighs the future reward of adequate income replacement.



In defense of humanity, there was a time when temporal discounting was an evolutionary advantage. An early human that thought too far into the future might miss an immediate threat or opportunity. Pre-historic people learned to eat when food was available, hunt when game crossed their path, and paid attention to their immediate surroundings to avoid danger. These behaviors promoted the survival of early humans.



We carry these adaptations as&nbsp;<a href="http://www.plansponsor.com/Five-Behaviors-That-Sabotage-Retirement-Savings/" target="_blank" rel="noreferrer noopener">hard-wired</a>&nbsp;reflexes into the world today. But most of us will live much longer than early humans, and we have to think beyond the threat of the saber-toothed tiger. The only thing getting eaten is our retirement security.



If the temptation to tap retirement plans to address more immediate financial needs is hard wired, then policy changes designed to address the savings gap due to leakages must reflect an understanding of human behavior. Liquidity and personal control might encourage supplemental savings in 401(k) and Individual Retirement Accounts (IRAs) when defined benefit plans are available as a core source of income in retirement. As 401(k)s and IRAs eclipse defined benefit plans as the primary source of income in retirement, the ability to access retirement savings may set retirement security on a path to extinction.

Robbing From Ourselves: Why Our Ancestry May Be to Blame

Why do so many employees leave their contributions in a plan’s default fund rather than set up a more favorable <a href="https://www.copera.org/the-field-of-behavioral-finance" class="broken_link">asset allocation</a>? Why would a retirement plan participant with a long time horizon corral their contributions in an overly conservative fund? Why are participation rates not higher in retirement plans even when employers offer a match? These and many other questions are the subject of behavioral finance, a growing academic field that brings psychology and economics together to address impediments to sound financial behavior. The field of behavioral finance seeks to understand human behavior around financial decisions in order to develop solutions that work in concert with our natural tendencies.



Retirement plans that incorporate behavioral finance findings have demonstrated success at not only increasing the number of people participating in their plans, but also increasing the amount people are saving for retirement. Behavioral finance findings provide a pathway to closing the savings gap. While behavioral finance recommendations apply in myriad contexts, Colorado PERA’s Defined Benefit Plan addresses two behaviors that impede effective saving: inertia and present bias.



<h5 class="wp-block-heading">Inertia</h5>



When in need of an organ transplant, head to Austria, not Germany. <a href="http://www.dangoldstein.com/papers/JohnsonGoldstein_Defaults_Transplantation2004.pdf" target="_blank" rel="noreferrer noopener">Research</a> that highlights a 99 percent participation rate for organ donation in Austria and a 12 percent participation rate in Germany has sweeping implications for removing behavioral barriers to saving for retirement. What accounts for the difference between these fairly similar countries? It is inertia, and its steadfast companion, the unchecked box. Nobody checks boxes. Nobel Prize winning economist Daniel Kahneman and author of Thinking, Fast and Slow explains, “In the economy of action, effort is a cost, and the acquisition of skill is driven by the balance of benefits and costs. Laziness is built deep into our nature.”



Inertia is one of many observable phenomena that the field of behavioral finance has identified to explain why we aren’t saving enough for retirement. Applicants for a driver’s license in Austria check the organ donation box if they do not want to be organ donors, while in Germany, applicants check the box if they do want to be organ donors. The implications of an ample supply of available organs in Austria and a shortage in Germany can mean life and death. While failure to sign up for an employer-sponsored retirement plan may not be as critical for survival as an organ transplant, a lack of retirement savings places people at risk of a substantial gap between the income they will need once they stop working and what is available to live without steady income from working.



This natural tendency toward inertia is the basis for recommendations to implement <a href="http://www.ebri.org/publications/ib/?fa=ibDisp&amp;content_id=4495" target="_blank" rel="noreferrer noopener">auto enrollment</a> and mandatory participation in a retirement plan. If doing nothing is the most frequent response from people about saving for retirement, employees should be required to opt out of a retirement plan rather than opt in. Defined benefit plans like PERA go a step further, and simply require participation. This ensures that participants contribute savings to their own retirement fund. The only opt-out option for PERA Defined Benefit Plan participants is an account rollover or refund when leaving employment.



Defined contribution plan administrators have been slow to adopt auto enrollment despite success in test programs like <a href="https://www.copera.org/the-field-of-behavioral-finance" target="_blank" rel="noreferrer noopener" class="broken_link">Save More, Tomorrow</a>. Only 55 percent of the 500 employers surveyed by Aon Hewitt in late 2011 auto enrolled plan participants, and of those who auto enrolled participants, only 63 percent of employers enrolled participants at a level that allowed for the full company match. These 500 employers represent 12 million plan participants. Without the structure of a defined benefit plan, individuals enroll at a lower rate and save less when they do enroll.



<h5 class="wp-block-heading">Present Bias</h5>



It is much easier to plan to eat less refined sugar and to exercise regularly next week than it is to avoid the box of donuts in the break room right now or to lace up the tennis shoes for a workout within the next half hour. Economist Robert Strotz in his article <a href="http://econweb.ucsd.edu/~jandreon/Econ264/papers/Strotz%20RES%201956.pdf" target="_blank" rel="noreferrer noopener">Myopia and Inconsistency</a> was the first (1955) to identify the best intentions of a future self. Since then, myriad studies have chronicled our willingness to trade a larger reward in the long term for an immediate, lesser reward.



Save More, Tomorrow program designers Shlomo Benartzi and Richard Thaler seek to address the impediments of present bias when it comes to saving for retirement. Because our brains are wired to favor “<a href="http://www.aon.com/attachments/human-capital-consulting/Article_BQRetirementBehavioralEconQ32013.pdf" target="_blank" rel="noreferrer noopener">near-term gratification at the expense of long-term gain</a>,” our best plans to save tomorrow take a backseat to today’s demands on income. Benartzi explains in a November 2011 <a href="http://www.ted.com/talks/shlomo_benartzi_saving_more_tomorrow" target="_blank" rel="noreferrer noopener">Ted Talk</a> that self-control is not a problem in the future, it is a problem now. We have no problem identifying the good behavior that our future selves will do. The challenge is getting the buy-in of your present self to uphold those great ideas you had for the future. In defined contribution plans, auto escalation, or a gradual, automatic increase in the percentage of salary being put away, works in concert with our best intentions for the future and guards against the sabotage our present selves commit.



Using a percentage of pay to begin with and committing to a future increase is the best way to work with present bias to mitigate the adverse effects when it comes to saving enough. All PERA members have the option to enroll in the PERAPlus 401(k) Plan, and some employers also offer the PERAPlus 457 Plan as a supplemental voluntary retirement savings vehicle for their employees. By starting with a percentage of pay as the first contribution, and committing to dedicate future salary increases—even by a single percentage of salary—a supplemental savings account can be used to buy service credit in the PERA Defined Benefit plan, offset the costs of health care in retirement, or for travel, or other purchases in retirement.



Present bias is a worthy adversary and is feeding the anxiety of both defined contribution plan participants and administrators. A quick review of present bias literature outlines the behavior in countless examples, and makes an easy argument for auto escalation in whatever style retirement plan an employer offers.



Organizations exert a great deal of effort to set up and administer retirement plans to round out total compensation. Defined benefit plans, where contributions are automatic, circumvent some of the toughest challenges plan administrators face when it comes to encouraging people to save. If more plans were set up to work with the natural tendencies of participants, then authentic retirement security would be a possibility.



The field of behavioral finance has a comprehensive and growing body of research specific to retirement that supports adjustments to plan design. The greater recognition participants have about inertia and present bias concepts, the more success they will have in closing the gap between savings and what will be needed in retirement.

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