UpFront | Published in September 2016

Using Plan Design to Address
Cognitive Ability

How aging impacts financial decisionmaking and what plan sponsors can do to help

By Rebecca Moore | September 2016
Financial advisers may have to deal with retired clients’ cognitive decline, but State Street Global Advisors (SSGA) contends there are things retirement plan sponsors can do to help participants prepare for retirement before their mental capacity begins to erode.

SSGA reached out to Harvard University behavioral economist David Laibson, who has done pioneering work on how aging affects financial decisionmaking. Laibson identifies two kinds of intelligence that evolve over a person’s lifetime: fluid intelligence—the ability to learn and adapt, which declines rapidly over time; and crystallized intelligence—wisdom learned from experience, which increases over time.

Cognitive performance, which draws on both fluid and crystallized intelligence, peaks when people are in their 50s. Laibson explored the connection between people’s age and the interest rates they paid for loans, and his research indicates people are best at making financial decisions in middle age, then that ability falls off.

Fredrik Axsater, global head of defined contribution (DC) at SSGA in San Francisco, says, “Anything we do within our business focuses on making retirement work. Taking into account the aging brain, to help people make the right decisions at the right time is important.”

What Can Plan Sponsors Do?

Laibson’s work shows that young investors are shorter on crystallized intelligence, as is apparent in the financial literacy scores of younger retirement plan participants, Axsater notes. He recommends that plan sponsors use automation—such as auto-enrollment and auto-escalation. “Younger participants realize that saving, and saving early, is important, but they don’t necessarily do it themselves,” he says.

SSGA advocates holistic approaches to financial wellness, but, Axsater says, while raising financial literacy is good to do, participants are more receptive to education at “inflection points” in their lives, such as when they get married or buy a home.

According to Laibson’s research, participants start to see the sense in planning for their financial needs in retirement at around age 50, Axsater says. That is the time to engage participants. Typically, they start to make decisions about retirement in their 60s, and they need to do this earlier, he notes.

Axsater suggests that plan sponsors provide in-plan retirement income strategies that include some form of annuitization—a feature that will be easy, or automatic, for active plan participants to adopt. “I think plan sponsors should evaluate all different forms of periodic payments, but we see that in-plan annuities that are part of a default are more effective,” he says. “If trying to address longevity risk, deferred annuities are best.” He adds that this is what plan sponsors should do to move participants from hope for what they can do in retirement to being able to predict what their income will be.