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Why Do (or Don’t) People Invest in Retirement Planning Products?

Retirement planning is critical to avoid drastic changes in lifestyle post-retirement due to lack of income. Yet, a majority of people do not plan for their retirement. Factors like income, savings, risk tolerance, and financial literacy affect people’s choices regarding financial planning. To encourage them to save more for post-retirement years, financial services professionals can design products considering all these factors. They can also use counselling, simplifying financial documents, and financial literacy courses to encourage people to buy retirement products.

Most people have to make drastic changes to their lifestyle after retirement as a result of significant reductions in income. Even in countries with social security, there is no guarantee

that living standards will be maintained after retirement. Thanks to increasing life expectancy, retirees have to face the prospect of outliving their savings. This is a serious issue as the proportion of those above 60 is rising globally (currently approx. 10%). Therefore, retirement planning is crucial, and understanding the factors that impact retirement planning is crucial . A study examines the question: How do risk tolerance, financial literacy, income, savings, and debt impact people’s retirement planning?

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Retirement planning implies preparation for a post-retirement life based on one’s financial

situation and desired future lifestyle. Retirement planning behaviour is manifested as buying of or investing in retirement planning instruments or products. The study found that internal factors like risk tolerance and financial literacy, and external factors like income, and savings affect retirement planning, while debt has no impact on it.

Income has a direct and positive relationship with retirement planning. That is, a higher

income leads to a greater desire for retirement savings to meet current levels of consumption post-retirement. It also causes a greater demand for retirement planning. Similarly, savings is also positively related to retirement planning. If a person has a qualified savings plan (plans with tax-deferred contributions) like a 401(k) in the US (Indian equivalents are the PPF, EPF and the NPS), they are more interested and more likely to engage in retirement planning.

Financial literacy also impacts retirement planning positively. Financial literacy is defined as

the ability to make financial decisions based on information related to financial planning, savings, and retirement planning. Higher subjective financial literacy (individual’s perception of their own level of financial literacy) encourages people to invest more in retirement planning.

Another factor that affects retirement planning is risk tolerance. It is the amount of

uncertainty an individual is willing to accept regarding the outcome of a financial decision. Higher risk is believed to provide higher returns in the long term. Therefore, those with a higher appetite for risk usually have more wealth at retirement and purchase more retirement planning products. Further, risk tolerance also affects the relationship between savings and retirement planning. Those with a higher tolerance for risk buy retirement planning regardless of their savings volume.

Surprisingly, debt does not correlate with retirement planning. One would expect that

having debt would reduce a person’s willingness to engage in retirement planning. However, the study found no such impact. This could be because of the nature of debt considered by the study. Long-term debt like a housing loan is already accounted for in an individual’s or family’s financial planning, so it may not affect their retirement planning adversely.

The study has relevant implications for financial services professionals. For instance, while designing products, they should consider the impact of internal factors like risk tolerance and subjective financial literacy, as these also impact a potential customer’s purchase decision. Since both financial and psychological support are needed to improve consumers’ well-being through investment in retirement benefits, programs can be created to improve access to these through proper counselling.

The financial services industry also needs to modify the way it operates so that there are

services available to customers with poor financial literacy. Moreover, they should make it easier for such consumers to understand complex financial information more easily. For example, they could simplify the language of financial documents. Or they could run easy-to-understand financial literacy courses at no or nominal cost. Even policymakers could work with industry professionals to implement such courses. Helping customers feel more confident about retirement savings will benefit individuals, the financial services sector, and the economy.

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