Retirement Planning Is Relative, But Inflection Points Do Matter

Part of what makes universal retirement planning advice hard to apply is that consumption datasets are inherently noisy, and “savings is the flip side of consumption.”

Defined contribution (DC) plan industry researchers and executives alike have highlighted the important role of “retirement planning inflection points” that hold across demographic groups and income stratifications, but there are important challenges to overcome with this style of thinking.

Retirement planning inflection points represent common events shared widely across peoples’ lives and which generally have a similar financial impact—getting married, buying a first home, starting a family—so it makes sense to think about how these might impact the retirement savings effort at large.

It’s an increasingly relevant conversation because in some ways the whole target-date fund (TDF) premise is built on the concept that common inflection points will impact peoples’ finances in a similar way, and that the inflection points arrive at roughly the same time. This is what give shape to the glide path, in other words.

One of the most commonly discussed inflection points comes when grown children become financially independent and finally fly the coup. A recent paper from the Center for Retirement Research (CRR) staffers Irena Dushi, Alicia H. Munnell, Geoffrey T. Sanzenbacher and Anthony Webb, for example, seeks to map the impact on mom and dad’s savings effort when grown children move out and start paying their own way in the world.

As explained in the paper, “much of the disagreement over whether households are adequately prepared for retirement reflects differences in assumptions regarding the extent to which consumption declines when the kids leave home.” The researchers ask whether, if consumption declines substantially when the kids leave home, as many lifecycle models of retirement savings assume, households might actually need to achieve lower replacement rates in retirement and need to accumulate less wealth than would otherwise be suggested.

NEXT: What the data bears out 

Using administrative tax data from the Health and Retirement Study (HRS), as well as the Survey of Income and Program Participation (SIPP), the paper in fact finds households are able to increase contributions to 401(k) plans by an average 0.3% to 1.0% in the years after their kids leave home—making this one of the more reliable inflection points. Critically, the CRR researchers find this pattern of increased savings holds “across datasets and for alternative definitions of the kids leaving home.”

Perhaps more important, the CRR researchers warn the increase in 401(k) contributions is “only a fraction of that predicted by lifecycle models that assume consumption declines substantially when the kids leave.” It’s a great example of how inflection point thinking is both informative and misleading when it comes to shaping an given individual’s retirement savings plan.  

The research findings continue, looking at the reliability of home purchases as retirement planning inflection points: “Home-owning households whose kids leave home are also less likely to have a mortgage than other households, suggesting higher post-kid payments, but the amount of increased savings implied is again much smaller than predicted by the lifecycle model.”

Part of the problem in relying on inflection points, which anecdotal and more rigorous evidence suggest are in fact great times to contact a given individual about improving their retirement readiness outlook, is that consumption patterns are inherently noisy. In reality there is no standard age for marriage or buying a house in our society, so while patterns do emerge in very large groups of people over large time spans, they’re not necessarily reliable indicators of where a given individual is likely to be in life, financially speaking, at a given date.

In a recent interview with PLANADVISER, Fredrik Axsater, State Street Global Advisors’ head of global defined contribution, says his firm has been thinking a lot about inflection points—especially how to take better advantage of them from a participant communication perspective. In short, he says, taking better advantage of data will be the key to truly leverage these retirement planning inflection points to boost retirement readiness for individuals and across real DC plan populations.

NEXT: Improving inflection point thinking 

Axsater’s role is a global one, he notes, and he has seen clearly that inflection points are one of the helpful commonalities when trying to understand and preempt trends taking shape across developed DC planning markets in the U.S., U.K., Australia, Germany and elsewhere. Across these markets, he says one major push is to move away from general advice about inflection points (delivered at essentially random times to all members of a plan population) in favor of more tailored advice that is delivered at highly coordinated times based on real-world data.

For example, a DC plan communication strategy could be designed which would automatically send an email with relevant savings tips and calculators to an individual in the days immediately after he or she signs a new mortgage. This level of coordination is already possible, Axsater says, but to really take off it will require stronger partnership between recordkeepers, other financial services firms (commercial and savings banks in particular), and plan officials themselves, all working in concert to get the right data triggers and communication responses in place.  

He points to a recent white paper published by the firm, which shows that most employees are still not working with an adviser. Axsater says this drives plan sponsors to look for opportunities to engage workers with other sources of guidance and advice—especially worksheets, tools or calculators that provide saving and investing guidance tailored to individual circumstances.

“We already have very good empirical evidence that these tools can substantially boost confidence when delivered and used at inflection points,” Axsater says, highlighting the critical time element involved in effective retirement education.

Perhaps the most influential inflection point the industry is thinking more and more about, Axsater concludes, coincides with the transition from retirement accumulation to retirement spending. This is a time period when one faces decisions that can dramatically boost or wreck retirement security, so it only makes sense that people are hungry for guidance at that point. (See “Beware the Retirement Red Zone.”) 

“That is one of our concerns with the ongoing discussion in the U.S. around new fiduciary regulations,” he adds. “It's very important that people have access to the advice then need at each inflection point, and we've made this point repeatedly in our comment letters.”