Retirement saving is hard even for people who can afford it

COVID-19 has thrown a wrench in retirement planning. Rising unemployment, a volatile stock market and economic uncertainty are jeopardizing the ability of many families to plan for the future. However, even before the pandemic, saving for retirement was not easy. 

According to a U.S. Federal Reserve report from 2018, one in four non-retired households had no retirement savings at all, and more than 40% of non-retired adults said their retirement savings were not on track. Even for those households with the means to save, employers shifting from defined-benefit plans (where they completely pay for and guarantee retirement income) to defined-contribution plans like 401(k)s (where employees contribute, participation is voluntary and there are no guarantees) made putting money away more complicated.

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Why? Research has shown that the voluntary nature of these defined-contribution plans created room for some common psychological blind spots to get in the way of saving. For example, studies have found that when it comes to actively managing retirement plans, most people default to not doing anything year after year. Psychologists call this status quo bias, as it is far easier for someone to do nothing, and maintain the status quo, than to take action.

Another blind spot is hyperbolic discounting, which occurs when someone puts too much weight on the present when making decisions about their money. As a result, they focus on how much money they have in the short term and tend to save less for the long run.

Both status quo bias and hyperbolic discounting tend to result in mistakes like not saving enough or not saving at all. There are other influences to watch out for as well. My own research has found that mental health issues such as anxiety and depression can decrease a person’s probability of holding a retirement account and a person’s retirement savings as a share of financial assets. These issues also are associated with having less money in retirement accounts and a greater probability of withdrawing from them. This is particularly pertinent today, as the COVID crisis has intensified depression and anxiety for many.

How can individuals overcome these influences? Recognizing blind spots can be difficult and even awareness of them is not sufficient to stop their effect on behavior. The best way to prevent them from affecting savings and financial future is to put the right processes in place.

If individuals don’t have any retirement savings and they have the option to participate in a voluntary contribution plan through their employer, they should sign up now. If their employer does not have a defined-benefit or defined-contribution plan or they are self-employed, they should set up an individual retirement account with their bank or another financial institution.   

If individuals already have a retirement account, they can make it easier to contribute by setting up direct deposits to their account. Making these deposits automatic each month can help sidestep hyperbolic discounting and other issues influencing how much one saves. The status quo will become regularly putting money away for retirement.

People should also be wary of making withdrawals. The Internal Revenue Service recently relaxed some of the restrictions and penalties for early retirement withdrawals during the pandemic. However, withdrawing early should be a last resort. These funds take years to accumulate and could take years to replace. People who are nearing retirement may not have adequate time to make up for the withdrawal before they retire. Also, unless they are tapping into a Roth IRA that they contributed to with after-tax income, they will owe taxes on the money that they take out.

Following these guidelines can go a long way toward boosting financial security.  Making regular contributions into, and avoiding early withdrawals from, a retirement nest egg not only increases the current balance but also helps the future balance grow exponentially. During tumultuous times, it is easy to discount the future, but now is precisely the time to start planning ahead.

Vicki Bogan is an associate professor in the SC Johnson College of Business at Cornell University.

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