How 'nudges' can be used to encourage people to save for their retirement

Employing subtle ways to help people change deep-rooted behavioural patterns could help them improve their financial position at retirement.

Persuading people of the importance of saving sufficient money for their retirement has been a significant policy aim of government. However, most people lack the financial skills required to plan their savings adequately, and many struggle to commit to a long-term savings and investment plan. This utimately can have a negative effect on the quality of retirement they will enjoy.

A paper from the Pensions Institute looks at how Behavioural Economics can help savers overcome the behavioural barriers and biases that de-rail their efforts to save for the future..

Behavioural Economics combines economics, finance, psychology, and sociology. It recognises that there are limits to the extent individuals are able to try to maximise their personal welfare, so the importance of "nudging" them towards optimal solutions is stressed.

This approach has already been used to promote saving in the so-called accumulation phase, when people are saving for retirement. The "save more tomorrow" (or SMART) plan has proved popular in the US. These plans are designed to help savers overcome behavioural barriers that are present pre-retirement, such as a lack of willpower to commit to long-term saving.They promote devices such as auto-enrolment with payroll deduction, auto-escalation, and withdrawal restrictions, and are sustained by inertia, where workers typically do not cancel once they've signed up to something.

This paper argues that similar "nudging" techniques could encourage better pension management in the decumulation stage, when people have retired and are drawing down their assets. The SPEEDOMETER retirement expenditure plan is designed to help people "spend optimally through retirement." The plan involves four key behavioural nudges: making the plan initially; automatic phasing of annuitisation; capital protection in the form of 'money back' annuities; and the slogan 'spend more today safely' to reinforce that 'buying an annuity is a smart thing to do'.

Networks also have a role to play in supporting individuals to improve their financial outcomes. There are a variety of possible networks, such as employment-based networks, social networks, internet-based networks, age-based networks, and networks based on personality type.

Of course, there is no point nudging people towards a pension plan that is badly designed. People need reassurance that it pays to save for their retirement, and well-designed plans should be fundamental to efforts to encourage people to take financial provision for their later years more seriously.

The report Nudges and Networks: How to use behavioural economics to improve the life cycle savings-consumption balance can be downloaded at City Research Online.