Retirement Savings Schemes: Intro

Now that we have explored what nudges are and the different heuristics and biases that make them necessary, we will look at different examples of where nudges can be applied and why they would be needed (i.e. the heuristics/biases that we are trying to counter). To begin this series of articles, we will be looking at retirement savings schemes and how they can be improved.

When a person is employed, one of the first deductions from their pay stub after taxes is for their future pension, which is paid by both employee and employer. This money is deposited into a pension fund or retirement plan, depending on the country, and is invested into low-risk assets like gilts and bonds to generate a sustainable retirement portfolio. This differs from the early private pension plan or ‘defined benefit’ plans. These involved the employee agreeing to pay a certain cut of their pay which would then be repaid by the employer when they retired, with the goal being a continuous stream of income while the person is enjoying retirement. However, the success of this system rested on two main factors – the person stayed with that employer in the same job for the majority of their working life, and that the company they worked at stayed in business. These are both very large risks to take, considering they can drastically impact a person’s future, and in addition, the plans were very expensive to maintain.

Therefore, the majority of firms switched to the system we have now (the one we described earlier), which are known as ‘defined contribution’ plans. Despite this, there are numerous problems that were encountered when establishing these systems, and we will explore these issues faced, their causes and solutions, and how they have been implemented in different countries. We have decided to look at retirement savings schemes as a case study for the applications of nudges as it is prone to many of the heuristics and cognitive biases we explored previously, with drastic and irreversible consequences if an irrational choice is made. There are three major preventing factors that need to be tackled before a retirement savings scheme can be considered successful and effective, and we will explore what they are, their causes and the solutions, as well as the benefits for the economy. These three factors are the following – enrolment, savings rates and investment options.

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