Raise Your Retirement Literacy
Let's say you have $200 in a savings account. The account earns 10 percent interest per year. How much would you have in the account at the end of two years?
If you get the answer wrong, you have plenty of company.
Annamaria Lusardi, professor of economics at Dartmouth, and Olivia S. Mitchell, executive director of the Pension Research Council at the Wharton School of the University of Pennsylvania, have spent time trying to measure financial literacy -- how many of us have it and what that portends for our retirement.
In a paper published last month, they took a look at how a group of 1,700 people in their early 50s scored on three questions contained in the University of Michigan's Health and Retirement survey in 2004.
The first questions were:
1. If the chance of getting a disease is 10 percent, how many people out of 1,000 would be expected to get the disease?
2. If five people all have the winning number in the lottery, and the prize is $2 million, how much will each of them get?
More than 80 percent correctly answered question No. 1. But only half had the correct answer to question No. 2. "And more distressingly, only 18 percent correctly computed the compound interest question," Lusardi and Mitchell wrote. That's the question we started with, which was posed to only participants who got one of the first two questions right.
The nature of things is that many of you who are reading this column already have an interest in financial issues and probably aced all three. But many more people who don't have a natural interest in financial issues are being required to make smart decisions about saving and investing for retirement -- or face the dismal consequences in old age.
That's the result of the ongoing shift away from traditional pensions -- the old-fashioned kind that sends you a monthly payment for life -- to defined-contribution plans such as 401(k)s. The burden is on the individual to get it right, and many of us don't have the training or even the basic financial literacy to be confident we can.
When a company sets up a traditional pension plan, it does so with some high-priced help.
The company hires legal help to make sure the plan complies with Internal Revenue Service and Labor Department rules. It will probably hire an actuary and benefits consultant to help design a plan that helps make it competitive in attracting workers. The actuary will analyze the workforce to help project how long workers will live, how many will retire early, and how many will take a lump sum instead of a monthly pension. The company also will have someone to manage the plan's investments and someone to administer the plan and communicate with employees, said Christine Mahoney, a principle in Mercer Human Resource Consulting.