My grandparents had great pensions, and my parents have OK pension plans. Me though? I have none. The most I’ve been offered by any employer, is a group RRSP.
It used to be commonplace for employers to guarantee their employees a specific pension payout for remaining loyally employed with the company.
However, in recent years, a lot of employers have shifted the responsibility for your retirement income from their shoulders onto yours. The newer designed company savings plans are entirely dependent on your own savings and participation. These days, it’s far more prevalent for employers to offer matching programs – group RRSP’s are one way of doing this – where the employer contributes a certain amount, say $0.50 for every dollar that you contribute, up to a maximum amount.
Although there are some debatable sociological reasons for the shift, one thing is certain: It is less risky for an employer to contribute to a group RRSP than it is to guarantee a retirement pension for its entire workforce.
Nowadays, the common group RRSP doesn’t come with much security; the amount you receive at the end is not fixed in stone. Instead, it remains a nebulous number, dependent on interest rates, stock market fluctuations, and on your own participation.
Your own participation is where things get tricky.
In its annual report, How America Saves, The Vanguard Group, an investment management firm, says nearly 1 in 3 employees do not bother to sign up for voluntary employer-offered retirement savings programs.
Let’s step back for a second and analyze this. Say I have an investment that immediately pays you 50% return on every dollar you give me, up to a maximum of $1000. That means when you give me $1000, you get back $1,500 right away. In order to increase your confidence in the deal, we will use a close relative, say your mother, to mutually deposit our money. You give your mother $1,000 and I immediately give her $500 for you. Who would pass up this deal? Nobody!
Similarly, this is how most employer-offered retirement savings programs work today. You deposit money into a RRSP account, and your employer deposits funds to match your contribution. Why, then, would almost everyone take the deal involving Mom, yet nearly 1 in 3 people don’t take advantage of employer-offered retirement savings programs that do the same thing?
Although these two scenarios do seem very similar at first glance, there is one salient difference that explains why people pass up the free retirement money; that being the payout delay you endure with a retirement savings program.
Let me explain: In the investment deal offer involving your mother, you get your investment back almost immediately. With your employer’s retirement plan, however, there is a gap in time between depositing your money, and when you will reap the reward of your deposit (this being your retirement). This gap in time creates a cognitive disconnect. Behavioural economics call it “hyperbolic discounting”.
In essence, hyperbolic discounting is the human tendency to prefer smaller payoffs now, over larger payoffs later.
For example, if you offer people the choice between $45 now and $50 tomorrow, many will choose the immediate $45 being offered today. However, when offered $45 in one year, or $50 in one year, plus one day from now, they will choose to wait the extra day.
Even though you only need to wait one extra day in each scenario to receive the $50, we tend to become impatient when the reward is immediate. This occurs because we grossly discount the value of things we’ll receive in the future (hello, retirement).
In the back of our minds, we know we need to save for our golden years, but our hyperbolical minds discount the future, telling us to go on vacation this year, and worry about saving more next year.
Unfortunately though, the old cliché “tomorrow never comes,” rings especially true in this case. According to Vanguard’s research, only 12-15 per cent of all participants who are offered the opportunity to catch up on lost contributions, ever do so.
It’s not exactly a case of being crunched for cash either. Even among those with incomes over $100,000, only four in 10 made catch-up contributions. (Just think of all that extra RRSP contribution room you might have.)
Another common reason why people fall so far behind is that they put their contributions “on hold” when times get tough, and they start feeling the crunch.
During rough patches, we will convince ourselves we cannot give up certain things that we think we need, or are used to having. (Think about your cell phone, or cable television bill for a moment.) We will instead opt to skip or reduce our retirement plan payments to “save” ourselves a few hundred dollars each month.
Of course there are cases that people will need to stop contributions altogether, such as employment loss or serious illness.
With our own clients, we work hard to modify their expenses to keep them from going into the red each month. Skipping retirement contributions though, should be a last resort.
Here’s why: Even when people only intend to skip payments for a short time, without any accountability in place, several years can pass by rather quickly before they start contributing again. Often, they’ve lost a huge amount of accumulation time along the way, and they never catch up. Just like the Vanguard study suggests, that most do not even try.
Retirement is a costly proposition though, and the responsibility for accumulation, and stewardship of our future retirement income is a large one. We might be able to put it off, but it’s not something we can avoid forever. Eventually, all of us will age past our prime, even by George Burns standards.
Retirement is a consideration which needs to be taken seriously, no matter how alien, foreign, or far off into the future that reality might seem.
If you haven’t started contributing to your company matching retirement program, start today. Avoiding it means you are, quite literally, turning down free money.
If you must stop making contributions, find some way to be accountable, and get back on track as quickly as you can.
Even under the best of circumstances, a group RRSP will often not be enough to support certain lifestyles in retirement. Think of your savings as a fixed cost: take a certain amount off the top, right away, and put it in your retirement savings.
Admittedly, this can be harder than it seems because we are more willing, almost hardwired, to take a small reward sooner (in this case, the ‘reward’ is a slightly larger take home paycheck), rather than hold out for a larger reward at a later time, no matter how nonsensical that decision might be.
If you tweak your financial situation today, and get past your hyperbolic mind, you will reap the larger reward in your retirement years.