Reading-over the Financial Finesse blog on How to Avoid Borrowing From Your Retirement Plan, it struck me that most of the language in the retirement b2b media speaks in terms of “us” and “them” (sponsors and participants), and generally in the passive tense. Is there too much flexibility in retirement plans? That is somewhat given these days as many sponsors feel like they are pushing a string trying to get employees to retirement readiness. Having a flexible plan may sound good, but how much flexibility is a bad thing? Meeting with hundreds (even thousands) of plan sponsors each year, the sense of helplessness seems to be growing.
One area that can sink a retirement plan fast is drawing funds from your retirement plan. Loans against a plan, although sometimes necessary, can cost participants dearly and erase years of prudent planning. So, as a sponsor you can admonish employees about the pitfalls of withdrawals and advise how this hurts a retirement outcome, but to what end? Is it effective?
The Financial Finesse blog makes a good point but is a bit light on solutions and rationale. Emergencies are a part of life and need-based withdrawals are likely to happen. Having an emergency fund is sound advice as the article suggests, but how do we get there? How does the message get through and how can plan sponsors break through the inertia of human nature to affect a change in behavior?
Behavioral science may just hold the key to the appropriate path to changing participant behavior. One of the things that we teach in The Plan Sponsor University (TPSU) Programs across the country is the power of opt-in versus opt-out strategies. For example in Germany the organ donor program shows less than 12% of citizens opt-in to donate their organs, whereas in neighboring Austria 99% of citizens are organ donors. Why the huge disparity in behavior? Austria’s organ donor program is opt-out; Germany’s organ donor program is opt-in.
You may ask, what this has to do with reducing destructive behavior in a retirement plan? It speaks to the issue of behavioral science and of behavioral finance. What we see in the organ donor plans mentioned above is that citizens of both countries opted for the path of least resistance. Sure, we could encourage alternative to borrowing from a retirement plan, but if we created negative behavioral obstacles to doing so, we would likely be more successful. These include, proving need; waiting period, limits to the number and frequency of loans, etc.
In addition, when studies are conducted on primates trying to measure satisfaction and sense of dissatisfaction with profit and loss, the sense of loss is consistently greater than the satisfaction of winning. We hold these finding to be true in humans as well. We are beginning to learn that advice can take several forms, and when it comes to avoiding preventable loss, like the case of withdrawals, tough love may be the best medicine.
