Retirement Planning Insights
Behavioral Finance 101
What is Behavioral Finance?
Traditional theories pertaining to personal savings, the efficiency of markets, and other aspects of personal finance explain what people should do with their money. However, traditional economic theories don’t always do a good job of explaining how people actually behave. Why would that be the case? Professor of Wealth Management and Wealth Management Certified Professional® (WMCP®) Program Director, Michael Finke, PhD, CFP® tells us the answer can be found by understanding behavioral finance theories.
According to Finke, individuals tend to make mistakes, some of which they do over and over again. This phenomenon is known as “predictable irrationality.” For example, when markets fall as they did during the March 2020 COVID crash, investors will predictably sell stocks after they have fallen in value because many overreact to investment losses. Finance theory suggests that investors should instead buy stocks in order to rebalance.
Another example is the difficulty many people have with resisting the temptation to spend from more liquid savings. Finke states, “We all have this temptation. I’m a professor and I understand financial planning, but when my checking account gets too big, more boxes tend to show up from Amazon for some reason.” By acknowledging that a client may struggle with saving, a financial advisor can help clients save in such a way that they don’t have to struggle with temptation. They can advise clients to set aside the maximum amount for their 401k, place money in a brokerage account, set up automatic transfers of money so the client’s checking account doesn’t accumulate too much money, and more.
How Behavioral Finance Knowledge Can Help Advisors
Awareness of these behavioral phenomena allows advisors to adjust their planning strategies to help clients meet their goals. Another such phenomenon is the tendency to overweight small losses. Known as Prospect Theory, a concept discovered by Daniel Kahneman and Amos Tversky in the late 1970s, this phenomenon refers to a non-equivalency in people’s responses to gains and losses. According to Finke, “Gains tend to make people a little bit happy, while losses, even little ones, tend to make people irrationally upset.”
As such, clients tend to be exceedingly loss averse. Finke mentions several ways advisors can combat people’s irrationality towards losses by not giving quarterly performance updates or reframing information in a manner that does not elicit an emotional response.
Knowing behavioral biases allows financial advisors to predict how their clients may act in a certain scenario and help them achieve their long-term financial goals. However, not all people are the same. According to Finke, factors of a person’s personality can greatly impact how they will approach saving situations.
The Impact of Optimism
One such factor is optimism. According to Finke, optimists are more likely to save for retirement and make sound investing decisions when doing so. Part of the reasoning behind this is “dispositional optimism.” As Finke explains it, dispositional optimists are likely to expect the best outcome and plan accordingly. As such, these optimists believe they will live to see their eighties and nineties and make it a goal to maintain a high quality of life.
Optimists are more likely to live to see advanced age because they place a greater value on the future. Dispositional optimists will exercise, eat right, and plan well to make sure they live to their eighties and have the financial security to enjoy them.
Additional benefits of optimism occur when managing money. The average person takes a suboptimal amount of risk with their investments, typically electing for lower risk than may be optimal given their long-term goals. However, since optimists view losses as a temporary setback and believe the best outcome is still within their grasp, optimists will tend to take more risk and react less to losses.
For those who aren’t naturally optimistic, financial advisors can use framing to shed a more positive light on future goals. Pessimism can harm an individual’s motivation to take the necessary steps to plan for the future. After all, a pessimist might say, “What’s the use? The markets are stacked against me and I’ll never be able to save enough to have a comfortable retirement.” However, by hiring an impartial advisor who takes the emotional aspect out of planning, pessimists can mitigate their tendencies that work against long-term financial success.
This difference in viewpoint explains how people can generally have the same goals for retirement and some fall tremendously short while others wind up attaining their goals. Typically, people hope to maintain the same quality of life and ability to spend in retirement as they do in their working years. However, optimists tend to meet this goal more often than pessimists. This isn’t to say that optimists will always retire well and pessimists will not. But a positive outlook can certainly help.
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Insurance & Risk Management Insights
Using Life Insurance in a Retirement Plan
Much like how cereal can be a part of a balanced breakfast, life insurance can be part of a balanced and holistic retirement planning strategy; however, the first challenge to overcome when considering whether life insurance can be leveraged in your clients’ planning is the public’s waning knowledge on the subject. According to research, as of 2024 only half of Americans owned any kind of life insurance at all — this follows a steady decline from 63% ownership in 2011, leaving over 100 million people with a significant life insurance gap.1
Public perceptions on life insurance are often at odds with reality, especially among younger generations: only 36% of Gen Z individuals own life insurance, with rates generally increasing by age despite the utility of policies at any stage of life and the fact that such a gap leaves younger Americans uniquely vulnerable to life’s uncertainties. Many Americans believe life insurance is too expensive for them to afford, though nearly three-quarters of them overestimate its cost significantly; additionally, the number of different life insurance products (term life, whole life, universal life, etc.) are often confusing enough to make people avoid the subject.1
With retirement planning growing more complex and do-it-yourself each year, your clients considering retirement need all the income sources they can get. But should life insurance be one of those solutions? And how can financial professionals properly leverage it?
Why is Life Insurance Important?
On paper, life insurance is often simplistically understood as a death benefit: one or more individuals receiving compensation in the form of money upon the passing of another person to pay for expenses, supplement surviving loved ones, and other needs. However, retirement planning experts are highlighting the key role life insurance policies can play for advisors and clients alike — even when the policyholder/insured is still alive.
Much of this strategy has to do with leveraging cash value life insurance: a form of life insurance that policy holders pay cash into over time to build value, much like a 401(k) or IRA — and which they can later make withdrawals from largely tax-free. Such policies often have higher premiums for holders, and it’s true that taking out too much cash can eventually deplete death benefits, but experts say with proper management, clients really can have their cake and eat it, too. This is especially important when considering the possibility of a serious medical issue in old age and the expenses that come with it.
“The idea that you need to ‘lose to win’ with life insurance simply misses the many advantages of modern life insurance policies,” said College Professor of Practice Steve Parrish, JD, RICP®, CLU®, ChFC®, AEP®. “In some ways, these policies can do not just double duty, but triple duty for the retiree. If using a cash value policy with a long-term care (LTC) or chronic illness rider, that contract can provide tax-free retirement income for the healthy retiree, be a source of needed income for the retiree who incurs a long-term care event, and still ultimately pay out a tax-free death benefit to heirs.”
Paul Wetmore, MBA, LUTCF®, CLU®, FSCP®, an adjunct professor of insurance at The College, concurred with Parrish that using life insurance can actually reduce strain on a client’s other retirement planning assets and allow them to perform better over time.
“For example, a client without the hybrid life/LTC policy may need to have more assets earmarked for an unexpected need and be required to keep them set aside in something underperforming — maybe not in cash, but something low-risk and very liquid,” he said. “The lost performance on those assets may have a larger negative impact on retirement income when compared to the plan that has some current cash flow through life insurance.”
Life Insurance As a Retirement Plan
While many financial advisors may focus on planning for higher-income or affluent clients, experts emphasize that using life insurance in retirement planning isn’t just a strategy for that sought-after group, but one that can be applied to nearly any retirement plan. In fact, there’s even a term for it: Life Insurance Retirement Plan, or LIRP for short.
Despite popular perception, it’s often good to encourage clients to buy life insurance young so they can continue to pay into it as they age. That said, even with clients already in retirement, life insurance can still be a valuable investment. For those who may have maxed out their other savings vehicles like IRAs and 401(k)s, those who have dependents or a spouse relying on their financial support, or those who want to leave a legacy while still enjoying retirement, life insurance can be a valuable part of the retirement plan toolbox.2
In particular, married couples in which one partner is the primary source of income or caregiving or people who want to leave a legacy after they die can make strong use of life insurance as a retirement asset.
“In the first case, if one of those partners dies shortly after retirement, the surviving spouse may need life insurance either to replace the lost income of the deceased spouse or to pay for the costs of caregiving that that spouse was providing,” Parrish said. “In the second, tax-free life insurance is far more efficient as a legacy vehicle than leaving IRAs, 401(k)s, and other taxable accounts. Also, cash value life insurance can be a useful tool for securing a tax-favored source of retirement income that can help supplement other sources of retirement income and bridge Social Security.”
Wetmore agreed, but also notes that life insurance solutions may still differ subtly depending on the economic status of the client.
“Very wealthy clients may be more focused on strategic income tax-planning strategies rather than the long-term care benefits, as many high net worth clients are prepared to fund their likely health care from their assets instead of LTC insurance,” he said. “The vast ‘mass affluent’ population, though, will likely want to avoid significant asset depletion from a long-term care need through the hybrid policy benefits.”
In the end, using life insurance policies to fund a retirement plan should be considered in the context of clients’ unique goals — but especially in the context of tax planning, Parrish says it can be the ultimate flexible support option.
“Life insurance is a far more tax-efficient means of transferring wealth at death than 401(k)s or IRAs,” he said. “Keep in mind that more likely than not, the retiree’s children will be inheriting their parents’ wealth when the children are in their peak earning years and potentially in a high tax bracket. Also, research has shown that when retirees leave a known legacy rather than just leaving whatever is left over, they are happier in retirement. They can use life insurance for the legacy, and not feel guilty about spending their other retirement savings.”
More on Life Insurance and Retirement Planning
- Subscribe to Knowledge Hub+ today to view this session on using life insurance in retirement planning
- Specialize in insurance planning with the Chartered Life Underwriter® (CLU®) designation
- Enhance your retirement planning knowledge with the Retirement Income Certified Professional® (RICP®) designation
- Read our ultimate guide to choosing a life insurance policy
PhD, CFP®, CeFT® (Emeritus)
CFP®, MA
Ethics In Financial Services On-Demand Webcasts
Rethinking Strategic Support for the Workplace of the Future
The financial services industry is undergoing a major transition: veteran advisors are approaching retirement while Gen Z individuals are just entering the field with a slew of their own expectations. To navigate these changing workplace realities and foster trust, engagement, and long-term commitment in your practice, it’s crucial to understand Gen Z’s motivations and identify any gaps in early-career procedures.
This webcast provides an exploration and examination of Gen Z’s career motivations, financial advisor reflections on early career ethics and cultural gaps, implications for building a better future for the financial advisory profession, and more.
Viewers will come away from this webcast with a better understanding of new advisors’ expectations and communication strategies to strengthen trust across career stages.
Practice Management Insights
Why Employee Financial Literacy is Good for Business
Whether you’re a financial professional trying to counsel business owner clients, a firm owner looking to maximize benefits for your workforce, or a major company seeking to improve corporate culture, guiding employees toward financial wellness can seem daunting — but the good news is that not only are there free tools and programs that can provide a starting point into increasing financial knowledge, but the process itself has enormous upside potential to your business’s bottom line. Let’s examine what those benefits are…and where you can find programs that meet both your employees’ unique needs and your business goals.
Why Is Employee Financial Literacy Important?
According to recent research, members of Gen Z see financial services as the #1 most desirable field to work in1; and while there are many reasons for this, it is also true that many members of the rising generation want more out of a job than just a paycheck. They want to feel good about the job they’re doing, secure in their position, and work for a business that appreciates them as an individual and wants them to do well.
That said, money can very often be one of the top stressors in people’s lives, and many are not properly educated to handle issues like credit, debt, retirement, and other vital financial matters on their own in an increasingly complex financial system. A 2024 study by the TIAA Institute showed a cross-section of U.S. adults failed to even score 50% on average on a quiz of basic financial literacy and knowledge2; and our own 2023 Retirement Income Literacy Study demonstrated that retirement is an area of special urgency, with quiz-takers averaging a dismal 31% on a test of basic retirement planning knowledge.3
Clearly, financial education is a problem that needs to be addressed — and it goes without saying that employees who are better educated about financial matters are more inclined to make better financial decisions. Increased financial literacy can boost morale among your employees, as well as improving job satisfaction. Furthermore, being able to tell prospective employees that your company offers complimentary financial wellness programs can help bring top talent to your table, as well as keep the talent you do have for longer.4
But, you may ask, what’s in it for me? Let’s explain the benefits from a business standpoint.
How Employee Financial Literacy Boosts Your Business
When discussing the benefits of investing in employee financial literacy for a business, increased recruitment is an obvious benefit, as noted above; however, an even more valuable benefit may be the increased retention of the experienced and talented employees already present. With many statistics pointing to a problematic retirement and attrition “cliff” in financial services, anything that improves retention can cut down on the need to spend time and money hiring and training new employees, thus directly benefiting the bottom line.
Speaking of which, more educated employees are, generally speaking, happier and more productive employees: studies show 54% of employees facing financial difficulties may suffer from distraction, low production, and chronic absenteeism — all of which can negatively affect your business and your customer experience. Furthermore, less financial stress can also lead to better health, and in turn, lower disability and healthcare costs for your firm. Organizations with high employee morale and engagement tend to see 21% higher profitability across the board.4
Want to really get down to brass tacks? Instituting financial literacy programs also has regulatory and data benefits; certain types of programs can boost a company’s community impact scores while still delivering real value to employees, and the data the company gets from whatever financial wellness program they partner with or run can provide real-time insights into the issues employees are facing — as well as what the company can do about it.4
Where You Can Find Employee Financial Literacy Programs
Now that you’ve seen the very real benefits employee financial literacy programs can bring, the next question is: how do you find one? Of course, one could always build a program through a company intranet portal, standalone webinars, or small group coaching; some important points to remember when setting up such a program include using a universal assessment to identify employee pain points, meeting employees where they are on a diverse array of financial needs, scaling your software to deliver the program effectively en masse, and regular promotion.5
But let’s be honest: you’re here because you’re seeking a quick and easy solution to your most pressing needs on employee financial literacy for either yourself or your clients. And as a nonprofit institution dedicated to serving the financial services profession and society for nearly 100 years, The College is here to partner with you and make it happen. Our consumer financial education offerings include:
- A Spectrum of Legacies: A program focused on philanthropic goals and legacy planning, best for financial professionals and clients to work through together.
- Resilient Finances — Thriving With Disability: For those newly on disability or dealing with life-altering circumstances, this program offers invaluable insights on how to manage healthcare planning and expenses, disability benefits, and more.
- Know Yourself, Grow Your Wealth®: Available in English and Spanish, this trailblazing financial education and empowerment program invites your employees into a series of modules that will increase their knowledge of all the cornerstones of financial wellness including credit, debt, housing, taxation, investing, and more.
- The Retirement Course™: For employees who may be looking for reassurance on their retirement strategies, this program focuses on finding purpose and meaning in retirement, retirement strategy and psychology, long-term care considerations, and how to ensure their money lasts as long as they do.
All our programs are free and open to the public — so if you or anyone you know is interested in partnering with us on one or more of these employee financial literacy opportunities and licensing versions specific to individual goals, contact us today and see how The College can help you enhance financial wellness and business outcomes.
Ethics In Financial Services Insights
Center for Ethics Launches Responsible AI Program
The Responsible AI Program centers on a series of invite-only online roundtables that bring together leaders across financial services. These sessions emphasize peer-to-peer education, offering participants a space to share strategies, explore practical approaches to responsible AI development, and discuss implementation challenges. The goal is to equip financial leaders, particularly those in risk management functions such as privacy, compliance, ethics, legal, and enterprise risk, with the tools and insights necessary to make informed, responsible choices around AI deployment.
Leading this program is Jill Heinze, the Center’s new Responsible AI program director. Heinze is a digital product strategist and responsible AI advocate with two decades of experience conducting user and market research to create user-informed products and services. Over the past twelve years, she has worked with academic institutions and digital agencies to implement responsible digital technologies, most recently developing responsible AI evaluation frameworks and governance practices for Fortune 500 clients in high-risk industries. She is deeply committed to advancing responsible AI practices and supporting professionals in applying them to their everyday work.
Building on the foundation of work developed by the Center’s AI Ethics Strategy Fellow, Andrea Bonime-Blanc JD/PhD, Jill will lead the implementation as the Center continues to foster education and provide a resource for shared learning and guidance on strategies to develop and deploy AI responsibly, with trust at its core.
More on AI Ethics
Stay informed about our latest AI research and initiatives — follow us on LinkedIn for updates and insights.
Learn more about becoming a corporate supporter of our Alliance for Ethics in Financial Services to unlock exclusive invites to events and gain first access to our research.
Learn more about our work on AI in financial services by exploring our publications on this topic, including Adaptable Artificial Intelligence, AI Ethics and Life Insurance: Balancing Innovation with Access, and Five Key Questions for Ensuring Responsible AI in Financial Services. For additional insights on AI in financial services, visit the Center for Ethics’ News and Research page.