How cognitive biases can influence employee pension engagement
Jamie Jenkins | July 2, 2019
Jamie Jenkins, Head of Global Savings Policy at Standard Life Aberdeen, examines some of the ways of thinking – cognitive biases – that can influence financial decision-making and affect how employees engage with their pension.
As we know, it’s always beneficial for employees to take control of their finances and prepare for the future. But we also know that financial matters can be complex and overwhelming.
Generally, when people are faced with having to think about confusing subjects, they tend to follow established rules of thumb.
Rules of thumb, otherwise known as heuristics, are mental short cuts we all use to make hard decisions easier. As an example, most of us are familiar with the rule of thumb that says we should eat at least five portions of fruit and vegetables a day for good health. This five a day rule is a good illustration of a heuristic that helps us do something good for our wellbeing without having to think too hard.
The Pensions and Lifetime Savings Association (PLSA) use a heuristic like this to help savers think in a practical way about the kind of lifestyle they want to have in retirement. Their Retirement Living Standards give general figures that can be easily understood and used as a base line to set personal targets. So, roughly speaking, a single person will need around £10k a year to achieve the minimum living standard, £20k a year for moderate and £30k a year for comfortable. The hope is that one day these standards will be the rule of thumb for retirement planning.
Behavioural biases can help or hinder the efforts to improve saving for retirement
This is why it’s so helpful for employers to understand the role of human behaviours and behavioural biases. These habits of the mind can be crucial in influencing employee engagement with pension savings as they can help – or hinder – efforts to improve saving for retirement.
One cognitive bias that can have a negative connotation is known as the herd mentality, because it can mean people following each other without thinking. But the herd mentality can also be a positive trait when people are herding around a beneficial behaviour, for example employees in the workplace who feel they’re part of a larger group doing the right thing by saving for retirement.
In fact, the herd mentality is an important factor in the success of auto-enrolment, because we know that when employees talk to each other, they can reinforce positive behaviours.
To exploit the power of the herd mentality, employers could consider informing employees of positive statistics around pension participation in the workplace.
Other behavioural biases that can be used to support pension engagement
A more modern behavioural bias that could also work to support pension contributions is fear of missing out (FOMO). An employee might be motivated to join their workplace pension because of a fear of missing out on something that everyone else is doing – saving for their retirement.
Mental accounting is another behavioural bias that can have a positive effect on pension savings. This is when people mentally account for their money as if it’s assigned to a specific purpose. In other words, people may think: ‘This amount is going here, that amount is going over there and this is the amount I’ll put into my pension’. With mental accounting, employees can believe they have a clear purpose for their money and part of that is saving for their retirement.
In addition, the very structure of a pension, in that you can’t usually touch it until you’re 55 (this may change), does create some sort of framework for mental accounting. Because of this employers could look to encourage their employees to think: ‘I won’t touch this money I’m saving until my retirement, and what’s great is that my employer is paying into it too and it’s benefitting from tax relief.’
However, one danger of mental accounting is that some employees may believe their retirement is taken care of. But, of course, the income they ultimately have in retirement depends on many variables. It’s why it’s so important employees are encouraged to consider the potential future value of their pension savings and, if necessary and they can afford to do so, adjust how much they’re saving. It’s important to remember that a pension is an investment and its value can go down as well as up. It could be worth less than was paid in.
A multigenerational workplace can help increase engagement with pensions too. If, for example, a younger employee gets into conversation with older colleagues about their planned retirement, it can prompt them to think about retirement differently and to be more proactive about their pension savings. Or, if colleagues are discussing regret about the lack of savings they have for their retirement, it can make younger employees think more positively about the importance of their pension.
Understanding human behaviour is important for communications
Although financial matters can be overwhelming, you can support your employees in their decision making and make sure they’re not alone by regularly communicating with them about their pension savings. And having an understanding of behavioural biases can go a long way to help you use the right messaging in these communications.
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The views expressed in this blog should not be regarded as financial advice. If unsure you should seek financial advice. There is likely to be a charge for this.
It’s important to remember that a pension is a long-term investment and as such its value can go down as well as up. It could even be worth less than was paid in.
Tax rules and legislation can change. Your personal circumstances will have an impact on the tax you pay.
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