How to Help Your Middle-Class Clients Retire

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Dan Richards

Middle-class Americans face a retirement savings crisis. Based on a report by the Center for Retirement Research at Boston College, at the end of 2010 over half of Americans will be unable to maintain their pre-retirement lifestyle at age 65. Even among the top third of income-earners, 44% won’t be able to retire at 65 without a drop in living standards.

This may not be a big issue for advisors who serve affluent investors with multi-million dollar accounts. For most advisors, however, the bulk of their clients are middle-income, middle-class investors. And even advisors who focus on the top end of the market often work with the adult children of their clients, whose accounts are much smaller.

The news is not all bad, however. The burgeoning field of behavioral finance points to some simple methods to help clients save more, invest their savings more effectively and maintain motivation through tough patches. Using these methods, advisors can help middle-income clients take the steps to increase the odds of being able to retire when they want, how they want – and to reduce their stress along the way.

Helping clients increase savings rates

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University of Chicago economist Richard Thaler is one of pioneers in behavioral finance. In this New York Timesarticle earlier this month, he laid out a two-step formula to increase savings among middle-class Americans.

Make payroll savings plans mandatory. And second, incorporate design features that have been proven to dramatically increase savings levels.

Thaler suggested that the default entry level of savings in these plans needs to be higher. Three-quarters of existing plans start at 3% of savings, unless employees make a conscious decision to move to a higher level. As a starting point, he advocated increasing the default savings level to at least 5%. Employees would still be able to change this, of course, but we know that the power of inertia is such that few will.

Then Thaler moved to the real heart of his recommendation, to implement a plan that he calls Save More Tomorrow. The concept is simple: Don’t ask people to reduce their income today. Rather, ask for a commitment that a large proportion of future salary increases will be automatically allocated to increased savings.

Thaler referred to this program as automatic escalation. One of the first companies that implemented this plan saw a quadrupling of savings rates among employees over a four-year period, from 3.5% to 13%. In 2011, half of US companies with payroll savings plans offered this as an option; Thaler believes that all should. Further, he recommended that automatic escalation be the default option when people sign up for savings plans.

The positive results from automatic escalation plans have been replicated in other research. One recent academic paper explained why this approach is so effective. Some people are active savers, in which they make conscious decisions on how much to spend and to save. Most, however, are passive savers – their decision on saving depends on how much money they have left over after their expenses have been met.

Using the Save More Tomorrow approach, people are not asked to give anything up today and never see the money from future pay increases, so don’t feel the same sense of sacrifice that they otherwise would. Click here to read more about Richard Thaler’s research on automatic escalation programs.