Using Retirement Plan Design to Address Cognitive Ability

Financial advisers may have to deal with retired clients’ cognitive decline, but State Street Global Advisors (SSGA) contends there are things retirement plan sponsors can do to help participants prepare for retirement before their mental capacity begins to wear away.

SSGA reached out to Harvard behavioral economist David Laibson, who has done pioneering work on the ways aging affects financial decision-making. Laibson identifies two kinds of intelligence that evolve over a person’s lifetime: Fluid intelligence—the ability to learn and adapt, which declines rapidly over time; and Crystallized intelligence—wisdom learned from experience, which increases over time.

Cognitive performance, which draws on both fluid and crystallized intelligence, peaks when people are in their 50s. Laibson explored the connection between people’s age and the interest rates they paid for loans, and his research suggests people are better at making financial decisions in middle age then get worse at it.

SSGA offers an article, “The Challenge Every Participant Faces,” which goes into more detail about Laibson’s findings.

Fredrik Axsater, global head of defined contribution at SSGA, who is based in San Francisco, tells PLANSPONSOR, “Anything that we do within our business focuses on making retirement work. Taking into account the aging brain to help people make the right decisions at the right time is important.”

NEXT: What can plan sponsors do?

Laibson’s work shows that young investors don’t have as much crystallized intelligence, which can be seen in financial literacy scores for younger retirement plan participants, Axsater notes. He suggests plan sponsors use automation—auto enrollment and auto escalation. “Younger participants realize that saving and saving early is important, but they don’t necessarily do it themselves,” he says.

SSGA advocates holistic approaches to financial wellness, but Axsater says, while raising financial literacy is a good thing to do, participants are more receptive to education at “inflection points” in their lives, such as getting married or buying a home.

Laibson’s research suggests that around age 50, it starts to make sense for participants to plan on what their financial needs in retirement will be, according to Axsater. It is time to engage participants. Typically, he notes, participants start to make decisions about retirement in their 60s. Participants need to make retirement planning decisions earlier.

Axsater recommends that plan sponsors provide in-plan retirement income strategies that include some form of annuitization—a feature that is easy or automatic for active plan participants. “I think plan sponsors should evaluate all different forms of periodic payments, but we see in-plan annuities that are part of a default are more effective,” he says. “If trying to address longevity risk, deferred annuities are best. He adds that this is what plan sponsors should do to move participants from hope in what they can do in retirement to being able to predict what their income will be in retirement.

In conclusion, Axsater says he just came back from Australia where he met with retirement leaders. “The challenge of how we can help participants take care of their savings after retirement is universal.”