“Prepurchasing” takes the sting out of saving for retirement

The daunting disparity between a mountainous retirement goal, and the scant savings potential of a worker just starting out in a career, is a major psychological barrier to getting an early start on saving, suggests new research from TowerGroup.

Institutions often provide tools that project the need to accumulate a seemingly unattainable nest egg in the hundreds of thousands of dollars.

TowerGroup asserts that financial planning would be more effective if reframed around the idea of “prepurchasing” individual years of retirement income.

Its new research highlights a three layered approach that incorporates a planning orientation into day-to-day spending decisions.

These tiers include:

• Utilizing online bill payment with a “set-aside” account to separately fund and manage payment for sporadic, budget-busting expenses such as holiday gift giving, summer vacations, or insurance payments. This approach will help level out monthly spending, reduce credit card debt, and enable customers to identify additional dollars for investment.
• Infusing the loan approval process for mortgages and car loans with “lifetime affordability” estimates to better underscore competing demands to fund college education or retirement. In a hypothetical example, TowerGroup estimates a couple could accumulate over US$400,000 in additional assets during a
  working career by buying the basic edition of a car and saving the difference in payments compared to buying the luxury edition.
• Changing the retirement planning approach from accumulating a significant amount of assets over a lifetime, to an approach of “prepurchasing” a percentage of a future year’s retirement spending each working year. In a hypothetical example, a 25-year-old making US$30,000 could spend 4% of his
  income at age 25 to purchase 18% of his income need for his first year of retirement at age 65.

“Few financial institutions focus time with their customers on discussing spending relative to current and future income,” said Matt Schott, senior analyst
in the TowerGroup brokerage and wealth management practice and author of the research.

“The concept of ‘prepurchasing’ years of retirement during an individual’s working years helps to sidestep the huge psychological challenge of accumulating a massive nest egg. It offers a way to help make each dollar saved toward retirement feel more immediate and tangible to the customer. It also serves to highlight tradeoffs versus other major spending decisions such as home or car buying.”

Schott noted that if 80 million U.S. households in the lowest wealth tier each accumulated US$100,000 in additional assets through this method, the increased asset-based revenue would equate to five new financial services institutions the size of Merrill Lynch.

“While approaches like the ‘prepurchasing’ model or set-aside accounts tied to online bill payment will require change on the part of financial institutions, the potential rewards could equal hundreds of billions of dollars of additional revenue,” he said.