Financial Illiteracy, Irrational Thinking Prevents People from Saving for Retirement

He died at a ripe old age, having enjoyed long life, riches and honor, and his son Shlomo reigned in his stead. (1 Chronicles 29:28)

The ancient Greek storyteller Aesop wrote about the hard-working ant who toiled all summer to stock his anthill with food; winter comes, and he has enough to eat. But the foolhardy grasshopper gorges himself during the sunny season and doesn’t prepare for a rainy, cold day; winter comes, and the grasshopper goes hungry.

The moral is that if you want to succeed tomorrow, you have to start planning and working for the future today.

Fifteen hundred years after Aesop, researchers at Ben-Gurion University of the Negev in Beersheba say that a better financial education is needed to encourage workers to maintain pension funds. Because people are living into their 80s, 90s and even beyond, expanding life expectancy means that failure to do so will carry stiff fiscal price tag for future generations.

Most people in developed countries fail to plan sufficiently for retirement, write Dr. Ravit Rubinstein-Levi and Prof. Haim Kedar-Levy of BGU’s Guilford Glazer Faculty of Business and Management. They have just published their argument in an article titled “The Effect of Attitudes Regarding Retirement on Pension Savings,” published in the current edition of the journal Review of Economics & Finance.

As a result of this grasshopper-like behavior, most countries in the Organization of Economic Cooperation and Development (OECD) “will be faced in coming years with large social security expenditures to support aging populations at a time of expanding life-expectancy.”

The economists argue that most inhabitants of OECD countries fail to maintain pension funds or other savings plans during their working years that are required to sustain them in retirement.

They point to two main factors as main contributors to explain the phenomenon. One – in contradiction to the principals of the defined contribution savings system that is implemented in most OECD countries and holds workers responsible for their pension savings – is that workers insist that the government is responsible for maintaining a reasonable standard of living for them after their retirement.

The second reason is that employees tend not to acknowledge the need to retire at a certain age. 

“Most individuals are interested in maximizing personal benefit. Yet, while the classical economics approach stipulates that maximizing personal benefit would be carried out based on rational thinking only, the conscious balance theory maintains that individuals would act in every way to maximize benefit and reach a state of balance, including choosing an irrational behavior,” the authors write. In other words, “psychological theories suggesting that people without savings will more likely avoid the cognitive dissonance by ignoring the troubling information.”

The researchers note that in the last 11 years, Israeli law has required employers to pay into pension funds on behalf of their workers. This is similar to requirements in other OECD countries such as Belgium, Norway, Germany, Italy, France, Austria, Sweden and Great Britain.

However, they also show that enforcement of the law is derelict, particularly with regard to small businesses and temporary workers. They also note that throughout the Western world, only a minority of people save enough during their working careers to avoid a decline in living standards after retirement. As a result, poverty among the elderly will present a growing fiscal and social challenge for governments in the coming decades.

“Throughout the industrialized world, governments have shifted the onus of preparing for old age onto the shoulders of private individuals,” said. Rubinstein-Levi. “In Israel, this means that 50% of Israeli senior citizens would live below the poverty line were it not for National Insurance Institute (NII) payments. That figure goes down to 30% after the payments are made.

Changes in most Western countries’ pension systems have shifted the responsibility for pension savings from the state to its residents. “However, individuals are continuing to avoid making decisions regarding their pension savings, partially due to financial illiteracy as well as reluctance to deal with aging. The outcome is wide-ranging poverty among retirees,” the researchers wrote.

“Most individuals are incapable of answering simple questions relating to pension savings. Therefore, a majority of individuals in many countries avoid decision-making regarding their pension savings, or make incorrect…decisions.”

As a result, the economists wrote, the cost to the public coffers is large. Social Security [National Insurance] payments to senior citizens represents more than 6% of the national budget, more than 21% of the social programs budget and about 93% of the total NII budget, with more than 2.25 billion Israeli shekels paid out for support payments to the elderly population in 2014 alone.

“At the same time, the senior citizen pension stipend that our National Insurance Institute pays is very low, so many people can’t afford to maintain the lifestyles as retirees that they enjoyed during their working years. Many are left in dire poverty,” Rubinstein-Levi added.

To address the issue, the researchers recommend that policymakers act to improve financial education and stress the role of personal responsibility in maintaining standards of leaving after retirement. Accordingly, individuals will give more thought to their retirement and start planning it at a younger age, possibly by seeking aid from experts.

“It is true that public awareness about financial planning has gone up in recent years, but behavior has not changed significantly. In Israel, as in the US, Canada and other countries, people are not saving enough for retirement. As life expectancy continues to grow it is going to become more and more important to address this issue effectively in coming years,’ Dr. Rubinstein-Levi concluded.

It’s time for the grasshopper to learn from the ant on how to survive the cold winter of retirement.



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