Generally speaking, it doesn’t require much convincing to have someone agree that saving for retirement is a smart thing to do. And yet, browse through any article about saving for retirement or listen in on discussions taking place in Washington, D.C., today and you’ll likely hear questions like these: Why do nearly 3 in 4 small companies choose not to sponsor a retirement plan? Why do nearly a quarter of people with access to voluntary retirement plans choose not to invest in them? Why do so many people seemingly ignore the potential benefits of time and compounding, and procrastinate when it comes to joining their plan?
Many of these answers reside in one of the three key elements of retirement readiness: Access, Ability, and Willingness. These elements account for much of what happens – or doesn’t happen – when it comes to saving for something that’s way off into the future like retirement.
Access with ease, please!
Access has to do with whether or not some type of savings vehicle is accessible to you, and with what ease. Industry studies have shown that when a 401(k) plan is available to employees, the majority take advantage of it and join the plan. But for those who work for companies that choose not to sponsor a retirement plan, most fail to establish one on their own. There are, after all, products such as individual retirement accounts (also known as IRAs), available to those who wish – on their own account – to save for retirement. Yet, few open and contribute regularly to an IRA.
Needless to say, access – through your employer – is one of the key elements of retirement readiness. But here’s the rub. Small companies, who employ an important share of the American workforce, tend to choose against sponsoring a retirement plan. As a matter of fact, based on Social Security Administration data,1 only 28% of companies with fewer than ten employees sponsor a retirement plan. The reasons are varied and range from the perception of high cost to administrative burden. Lack of access can be even more problematic in the legal community because 9 out of 10 lawyers are in firms with fewer than ten attorneys.2 Extrapolating the information from the market at large, this would indicate that the propensity for law firms to be small means there may be lack of access to retirement vehicles such as 401(k)s, for many lawyers.
Law firms of all sizes need to acknowledge that a retirement plan is a benefit valued by its employees. Industry data shows that 81 percent of employees want a workplace retirement plan, but only 59 percent of small companies offer a retirement plan.3 Giving employees what they want is an important way of retaining talent and attracting new ones.
Ability pertains to an individual’s discretionary income and whether or not they have the ability to save in the first place. It is fair to recognize that some Americans simply do not have income left to save after meeting life’s necessities – rent, food, gas, debt repayment. But many do, or could with a little budgeting and planning. The nationwide median household income in the US is $61,937.4 When it comes to lawyers, the median income rises to $120,910.5 Certainly there’s a difference in frame of reference between these two groups but arguably neither is without the ability to save.
The choices we make, the things we spend money on, directly impact our ability to put money aside for the long-term. You may have heard of the $115,000 coffee habit, where a three-times-per-week $5 latte habit could have turned into more than $115,000 if invested over a 40-year period.5
Whether you’re a firm administrator, a paralegal, or a lawyer, there are opportunities to save money. One of the beauties of tax-deferred savings vehicles like 401(k)s is that they are deducted from payroll before the money gets in your hands. This helps tremendously to automate what you may lack in discipline. But you still have to take action, join the plan, and elect a deferral amount, which brings us to our last key element of retirement readiness.
The human willingness to believe precedes their ability to think
Even with access and the means available, many still don’t save for retirement. The final element of retirement readiness is willingness. Willingness is often tied to basic human behavior and is at the root cause of the lack of retirement preparedness for so many Americans. The investment community is realizing what advertisers have known since the dawn of advertising – that emotion drives action (and sometimes inaction). Understanding how emotions and psychology affect investment decisions lies in a relatively new field of study called behavioral finance, which combines psychology and finance economics. Here are a few examples:
One human predisposition is to perceive the “pain” of an immediate loss or sacrifice to be stronger than the perceived “benefits” of a conceptual, long-term gain. The perceived pain of giving up our $5 latte today is stronger that the potential benefits of saving that money over a 30- or 40-year career. This behavioral tendency is called hyperbolic discounting and is especially damaging for people struggling between the enjoyments of spending their money now on something they want versus potentially greater benefits later once they reach retirement.
In addition to discounting future gains for near term benefits, humans also have an aversion to loss. Studies show that the pain individuals feel when they lose cash is twice as strong as the joy they feel when they gain an item of equal value. This behavior is a leading cause to poor investment timing decisions – sell low to minimize losses and buy high to join in on the euphoria.
Fear of loss can magnify the effect of familiarity bias. What’s familiar can seem comfortable and safe. Our past experience is a powerful navigational system for our future actions. The net result can lead to inferior asset allocation, preferences for local stocks or industry and professional proximity – a lawyer investing in legal services stocks, for example.
Myriad emotional biases and natural tendencies challenge our best efforts to be rational thinkers. This often leads to paralysis, inaction, or poor decision making when it comes to saving for retirement. The good news is that the more we know about these behaviors the more we can prevent them through product design, education, and choice architecture. Automatic enrollment, target date funds, negative election, and Gamification are just a few of the relatively recent developments that help offset poor behavioral tendencies and boost willingness.
As we all march toward a common goal – to reach a safe and secure retirement – we need to acknowledge those three key elements. Employers, irrespective of their size, need to recognize the value a qualified retirement plan can bring to its employees and provide better access. Workers, irrespective of their income, need to commit to saving early and maintain that commitment through thick and thin to the best of their abilities. And savers, irrespective of their biases and tendencies, need to leverage the tools available to them and follow through on their willingness to save for retirement. Leveraging these key elements – access, ability, and willingness – will likely help you improve your retirement readiness.
- Retirement Plan Coverage by Firm Size: An Update, by Irena Dushi, Howard M. Iams, and Jules Lichtenstein, Social Security Bulletin, Vol. 75, No. 2, 2015
- The Lawyer Statistical Report, American Bar Foundation, 2012 Edition
- Striking Similarities and Disconcerting Disconnects: Employers, Workers and Retirement Security, 18th Annual Transamerica Retirement Survey, August 2018, Transamerica Center for Retirement Studies
- U.S. Census Bureau, Household Income: 2018, American Community Survey Briefs, by Gloria G. Guzman, Issued September 2019
- Bureau of Labor Statistics, Occupational Employment and Wages, May 2018, 23-1011 Lawyers (https://www.bls.gov/oes/current/oes231011.htm)
- This hypothetical scenario is not intended to reflect the performance of any particular investment. It reflects the growth of an investment of $60 per month for 40 years, at 6% average annual return. If the investment were made in a tax-deferred vehicle such as an employer’s 401(k), 403(b), or 457 plan, taxes would be due upon withdrawal at the investor’s current rate.
Press inquiries: Christine Hotwagner
Director, Program Operations
ABA Retirement Funds