Since many individual pension plan members make monthly contributions in fixed nominal amounts, for example €50 or €100 monthly, and most countries recorded double digit inflation in the last year, the only sensible thing to do would be to index contributions with the inflation rate, right? Since we know most members of pension plans are fairly passive when it comes to changing their contributions or investment policy, this is the place for smart automatic plan design features to step in and lend a helping hand to members. In the article below I will share our experience on how we indexed monthly contributions of our members and what was the outcome.
Saving for retirement is a long term project that can span over 40 years or more. This means that over the course of your career, inflation can erode the purchasing power of your savings and this is why it’s key to counteract it by increasing your contributions in line with inflation or even above it, allowing you to maintain a reasonable standard of living in retirement. By understanding the negative impact of inflation on retirement savings and taking appropriate steps to adapt our contributions, we can bolster our financial well-being and maintain a solid foundation for the years to come.
But let’s be realistic, most members of pension plans will, if left to themselves, not increase their contributions in line with inflation (the so called “set it and forget it” mentality) and this is why it’s very important retirement plans incorporate automatic features, like automatic indexation of contributions with inflation, automatic escalation of contributions, default investment policies in target date funds and similar.
We incorporated automatic indexation of contributions with inflation in all of the individual pension plans managed by the company I work for (Pokojninska družba A) and this April it was time to really test the theory. In April we indexed all contributions that were designated in fixed monthly amounts and the way we did it was as follows. In March we sent a notice to all individual members informing them we will index their contributions by 10,3% (this was the inflation rate in Slovenia last year) in the next month in accordance with the provisions of the pension plan and if they don’t agree with this course of action, they have to let us know until the end of the month. So we have a classic case of an opt-out policy meaning the default (if members do nothing) is, your contributions will be indexed with inflation. Only if you do something – in our case writing an email or letter to the pension plan, you can opt-out of this feature and your contributions will not be indexed.
Since the 10,3% planned hike was the largest we have ever done and the cost of living crisis was already in full play also in Slovenia with high electricity and food prices, many of my colleagues were quite sceptical about our plans and feared they might backfire. People will be mad at us, some may quit saving for retirement altogether, … were some of the comments. But having read tons of studies on similar opt-out policies we stayed the course. We notified all members about the proposed indexation and awaited their feedback (N= 381). After the month passed only 2,9% of members contacted us and told us not to index their contributions and an additional 0,5% wished to terminate their saving account altogether. This means that on the other side we increased contributions of the remaining 96,6% of members by 10,3% which is a huge success and will make a big difference over the long run on their assets at retirement.
To really measure the success of the opt-out policy in this particular case I could only wish to have a control group of members in which the opt-in approach would be used and in this case they would receive a different letter telling them they need to agree in writing to the proposed indexation and send us a signed form back expressing their approval. It’s tough to speculate what the results would be in this case, but I would be really surprised if we would get back forms from more than 30% of members. This would in the long run result in lower assets at retirement providing members with inadequate income.
Automatic indexation of contribution with inflation is something that can all too quickly be forgotten or ignored and the consequences of this inaction will not be felt for years to come. But once we are close to retirement and start looking at what kind of lifetime income our retirement nest egg generates, it’s too late to change things. This is why it’s crucial plan sponsors and pension funds managing plans think about this kind of details and incorporate automatic features that help savers on their way to a financially secure retirement. As our small case showed, the effects are huge.
Irrational Retirement 