DESIGNING AND COMMUNICATING RETIREMENT PLANS FOR “HUMANS”
Why did retirement plan sponsors and their advisers collectively decide it would be a good idea to require workers to be their own actuaries and investment managers? That’s exactly what happened when they replaced defined benefit (DB) plans with defined contribution (DC) retirement plans. With DC plans, workers must not only decide how much to save for retirement and how to invest these savings, but also how to deploy these savings to generate reliable, lifetime retirement income. In retrospect, there’s plenty of evidence that demonstrates this long-term trend has decreased retirement security and confidence among American workers
If Bill Sharpe, a Nobel prize winner in economics, thinks retirement income planning is a really hard problem, what results can we expect from average workers?
Richard Thaler, a prominent behavioral economist, tells us that conventional economic thinking assumes all people are “Econs” who rationally weigh all relevant facts when making financial decisions, are unbiased and consistent, and are cold-blooded optimizers who calculate like computers and don’t have self-control problems. But Thaler points out that most people are actually “Humans” who are limited in their ability to gather and analyze relevant facts, have biases and passions, and often make irrational, inconsistent decisions.
So why is it that most DC retirement plans are designed for Econs, not Humans? In an age of increased longevity, the consequences of making retirement income planning mistakes can be serious or even devastating. People might retire too soon before accumulating sufficient savings, or they may not know how to deploy these savings to generate reliable income for potentially lengthy retirements. Either way, there’s a significant possibility that many retirees will live some of their remaining years with inadequate retirement income or even in poverty.