Address Retirement Illiteracy and Confusion, Studies Argue

Much attention rightfully has been placed on the gap between what Americans need in order to finance their retirements, and what they have and/or are projected to amass. But recent studies uncover another gap relevant to retirement security — that between what they should know and what they actually know about retirement saving and the terms relevant to it.

In the white paper “Retirement 2058: What Artificial Intelligence Reveals About 401(k) Plans,” Dream Forward says that they found “a large disconnect between the way 401(k) plans are designed and the average American’s knowledge of financial terminology.”

The Journal of Financial Planning in “Retirement Income Literacy: A Key to Sustainable Retirement Planning” reports similar findings. They cite recent research that shows that just over 25% of retirement-age Americans passed a literacy quiz about retirement income, which the report says indicates “a lack of retirement income planning knowledge that limits clients’ participation in their own retirement decision-making and lowers their satisfaction with the process.” “Financial literacy is crucial to proper planning based on informed decisions,” says the report.

Dream Forward found that the highest degree of confusion concerned understanding withdrawal options. “Comprehending the differences between in-service withdrawals, 401(k) loans, early withdrawal penalties, hardship withdrawals, in-kind distributions, etc. is a challenge,” the white paper says, adding, “Participants really struggle to wrap their heads around the pros and cons of the multitude of withdrawal options.” Dream Forward also reported that understanding investment concepts ranked high among the sources of confusion.

Exacerbating the confusion are the financial concerns that respondents told Dream Forward affect their ability to save for retirement. The most common were: affording college, current or future medical expenses, buying a house, feeling financially insecure and not earning enough. The Journal’s report shows results that are almost a mirror image: running out of money, health care costs and factors that affect financial security, such as volatility in investment returns, Social Security cuts, inflation, tax rates, and long-term care expenses figured significantly.

Confusion, financial illiteracy and overweening concerns result in lack of engagement, the studies suggest, and Dream Forward argues that this is heightened by the way the retirement system in America has changed. “When America relied on a pension system, your employer was in charge of monitoring and managing retirement,” it notes. But now, it says, “it’s up to the individual to manage a retirement strategy properly, and it tends to be on the bottom of the to-do lists.”

Addressing the Problem

“Improved literacy scores are strongly correlated with key retirement income planning markers, such as having a retirement income plan in place, deferring Social Security, and making well-reasoned investments,” says the Journal’s report.

To reduce confusion, increase financial literacy, and facilitate and encourage engagement, Dream Forward suggests updating the rules and regulations governing rollovers and simplifying the rules and regulations governing 401(k)s. They also suggest better using technology to communicate with participants and beneficiaries when they are making decisions during enrollment, and to better assist participants with their questions and concerns.

“Short of going back to a mandatory system — something that seems highly unlikely — the next best thing is to try to redesign 401(k)s around getting people to save more,” says Dream Forward.