This blog is based on an article in the Journal of Social Policy. Click here to access the article.
One might think that saving into a pension scheme is rational behaviour. But this study suggests that reason isn’t the only motivation and building up an adequate retirement income isn’t the only aim of pension enrolment. Our research found that how and why we save for retirement can be influenced by our emotions. We can be driven by the expectations of family and friends or by our current hopes and fears. Behavioural biases matter too. The design of the pension scheme we are automatically enrolled into can influence how we act. It may cause us to attach undue importance to the contribution default settings when calculating how much to contribute.
We often refer to behavioural biases as irrational beliefs. Biases lead us to behave in ways that can negatively affect our wellbeing. For example, our myopic tendency to place greater value on the present than on the future – sometimes referred to as present day bias – can cause us to put off saving for retirement. Automatic enrolment counters behavioural biases such as myopia and procrastination. It helps overcome these barriers to saving and puts people into workplace pension schemes earlier than if they were left to their own devices.
Automatic enrolment works because it makes use of another behavioural bias – the status quo bias – to keep people enrolled and contributing to their pensions scheme. The status quo bias is an emotional bias for continuity and it acts to hinder change. Simply put, once enrolled in a scheme, the enrolment status becomes the new normal and we become reluctant to change our situation by opting out.
Our study suggests that enrolment might be automatic but this doesn’t mean remaining enrolled in a pension scheme is an unthinking act. Passivity is implicit in discussions about the success of automatic enrolment but individuals can be actively engaged in remaining automatically enrolled. We found that ‘ticking the savings box’ is important even if little thought has gone into calculating how much these savings will be worth at retirement. For some, sociological factors such as adhering to social norms may have a role to play in explaining pension scheme membership. How old we feel and where we are in our lives seems to matter more than how many years we are away from state pension age.
One finding from the study is that the meaning we attach to our savings is important. There is a subtle distinction between wanting to save for retirement and being willing to save enough. An example of this is individuals who, despite being committed to pensions, deliberately save very little. Under-saving for old age might appear sub-optimal—but this doesn’t necessarily mean it’s irrational. The research indicates that low pension saving is not just about affordability. How we intend spending our time, both now and in the future, can influence how much we save. Most of us also tend to place greater emotional value on acquiring assets such as housing than on building up pension funds.
An important finding from the research is that pension scheme design can influence savers’ future behaviour. The paper argues that we need to pay more attention to this potentially negative side of automatic enrolment. The initial default savings rate set by the employer and the level of their matching contribution seem to be important. If the default setting is set too low, an individual might find themselves under-saving for retirement. And the power of the status quo bias can work against them changing their contributions. Although some individuals are better able to overcome the status quo bias than others, the default can still influence subsequent financial decisions. The study suggests that defaults can subliminally sway how individuals increase contributions. Rationally we should calculate how much income our funds will bring us in retirement. But the study shows that some savers attach undue attention to the default settings. They use multiples of the minimum contribution as the basis on which to calculate how much more to contribute.
Behavioural biases are important but the paper argues that they do not take place in a vacuum. How and why we save for retirement is influenced by our emotional response to current economic and social policies. The more uncertainty occurs in other areas of our lives, the more likely we are to fall back on emotion and behavioural biases.
About the author
Lynne Roberston-Rose is Lecturer in Social and Public Policy at the University of Edinburgh.