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Retirement is a monumental life event for which people prepare for decades. It is marked by changes in virtually every area of one’s life, from work to relationships, and from health to self-identity. However, the most significant life domain relevant to retirement is money. Personal finances can make or break a person’s retirement and even dictate whether it happens at all. Today, personal finances are likely to be the most significant cause of anxiety for someone considering or close to retirement than any other issue. Why? In this blog post, I want to discuss four gaps related to personal finances that affect retirement preparation, producing anxiety and other adverse outcomes.
The Financial Knowledge Gap
For most people, retirement means stopping work and living off of the money they have saved and invested (in addition to social security benefits and pension, if applicable).
How much savings is the bare minimum required? How much will be needed for a comfortable post-work retirement? Obviously, the answers vary dramatically from person to person, requiring careful consideration of saving and consumption habits, lifestyle, health, and expectations about retirement, among other things. Once a target value or range is established, a path for how to get to that goal is also warranted. In other words, substantial domain knowledge, procedural knowledge, and personal knowledge of finances are required.
As a whole, Americans have a significant gap in financial knowledge. One 2019 study found that 56% of Americans don’t know how much they will need to save for retirement. Other studies have found that an even larger percentage have poor financial literacy and are unaware of their personal financial situation.
The Financial Resources Gap
Just as important is actual financial resources. An individual may deliberate and establish that they will need one million dollars when they retire at 67. However, such knowledge is only useful if they are able to earn and save consistently throughout their career to accumulate such a substantial nest egg. This is the financial resources gap, and for many people, it can be larger and more difficult to overcome than the knowledge gap.
Study after study finds Americans to have an inadequate amount of resources for retirement. In one recent study, 48% of older American households (headed by someone aged 55+) reported having no retirement savings at all. And the median retirement savings balance for this group was $12,000, far below any reasonable target value. Psychologically, too, this gap is far more difficult to close than the knowledge gap. It requires tough, long-term solutions at both the individual level, such as acquiring marketable skills, cultivating frugality and a savings habit, and at the social scale such as implementing policies to reduce income and wealth inequality.
The Financial Perception Gap
In addition to knowledge and wherewithal, perceptions about finances also play a significant role in retirement preparation. Over four decades of robust social psychological research has shown that self-efficacy dictates how individuals approach substantial long-term goals. According to social psychologists Robert Wood and Albert Bandura,
“Perceived self-efficacy refers to beliefs in one's capabilities to mobilize the motivation, cognitive resources, and courses of action needed to meet given situational demands. Self-beliefs of efficacy affect the challenges that are undertaken, the amount of effort expended in an endeavor, the level of perseverance in the face of difficulties, whether thinking patterns take self-aiding or self-impeding forms, and vulnerability to stress and depression.”
Because preparing for retirement is a decades-long endeavor requiring a range of activities, self-efficacy takes on added importance. Numerous studies find that Americans are unsure and lack confidence in the domain of retirement planning. For instance, one study found that only 13% of Americans were confident in their ability to eventually retire. Another study found that only 23% were satisfied in their ability to financially navigate through economic ups and downs. What’s more, perceptions about retirement preparation can also trend the other way, and be marked by over-confidence. A recent study conducted by the Employee Benefit Research Institute found that while 72% of retirees felt confident about being able to maintain a comfortable lifestyle in retirement, only 46% reported having a large enough nest egg to do so. This is a significant perception gap.
The Financial Empowerment Gap
Spanning each of the three retirement preparation gaps requires long-term planning and self-regulated behaviors involving money over the decades of a person’s working life. The underlying assumption is that the individual has chosen their retirement age, mid- to late-sixties for most people (and younger for those in the FIRE movement).
However, recent statistics suggest that this assumption may be unduly optimistic and untenable for many. A study conducted by the Alliance for Retired Americans found that from 2008 to 2014, more than 52% of retirees over 55 were forced to leave their last job, either because of layoffs or declining health. Consistently, another study reported that 47% of those who are currently retired did so involuntarily, often years or decades before their scheduled date. We can call this the empowerment gap to indicate that many people can’t choose when they retire. This can make post-retirement confusing, challenging and burdensome.
Each of these four financial gaps represents a significant challenge in preparing for retirement. In future posts, I will delve deeper into each gap, focusing on specific solutions, based on psychological research, by which individuals can close the gap.
