Behavioural economics and pensions

There was a fascinating paper published by the pensions institute in 2010 entitled ‘spend more today’ and it was about ways to encourage (or to use the economic vernacular ‘nudge’) people to take out pensions.

We realise that forty pages of technical reading may not be everybody’s cup of tea so here is the most brief synopsis we can offer you as an alternative. Just note that this isn’t what you ought to do per se, it is about how the system ought to work.

They put forward the idea of using ‘SPEEDOMETER‘ which stands for ‘Spending Optimally Throughout Retirement’, and the steps to take are as follows:

1: First make a plan, ideally with, but if necessary, without an advisor. This first point is of interest because we obviously think everybody should get advice when planning their pension, but upon reflection it’s equally true that a ‘start’, even with no advice is better than inaction and there is simple reason behind it.

Say you decided to start putting €200 a month into a pension, given that you might be getting about €80 of tax relief the ‘net cost’ is more like €120, but even if you went for the worst fund in history and made every bad choice, chances are you wouldn’t ‘lose’ that notional free €80 (which is the tax you didn’t have to pay), and even if markets crashed the next day, you have started and your fund isn’t big enough to be permanently swayed in the wrong direction so ‘getting started’ with or without’ advice is actually smart.

2: Automatic phasing of annuitization: Also called gradual ‘auto-enrolment’, a feature like this takes away the aversion to large irreversible transactions as well as flexibility of managing the run down of retirement assets. To a degree this is what ARF’s (approved retirement funds) do .

3: Capital protection: This is a ‘money back’ so that if you die before claiming you get something back and also deals with ‘loss aversion’.

4. Spend more today: This uses the idea that ‘spending’, and by that we really mean ‘buying a pension’ is a good idea. People need to bridge the idea that by viewing pension savings as a brand of consumption that you are living the good life and in turn, someday you’ll… live the good life!

If you want to read the full paper yourself, check out ‘Discussion paper PI-1014, ‘spend more today’.

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