LAURENCE J. KOTLIKOFF, Boston University - Department of Economics, National Bureau of Economic Research (NBER), CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Email: kotlikof@bu.edu
PAUL A. KOEHLER, Boston University
Email: authorkoehler@ssrn.com

This paper marks Social Security’s open group liability to market taking into account the riskiness of its aggregate benefit payments and tax receipts. The open group liability references the present value of the system’s net cash flow from now through the indefinite future. We treat the growth rates of the system’s aggregate benefits and taxes as implicit securities that are spanned by the returns on marketed securities. Our pricing of Social Security’s infinite horizon net liability builds on prior independent work by Blocker, Kotlikoff, and Ross (2009) and Geanakoplos and Zeldes (2009). Our results, which we view as preliminary, suggest that the market value of Social Security’s open group liability may be many times larger than the $15.1 trillion stated in the Trustees’ Report. Unlike Blocker, Kotlikoff, and Ross (2009), this discrepancy between our financial valuation and Social Security’s does not reflect differences in the value assumed for the safe rate of return. To control for this factor, we simply follow Social Security (and Geanakoplos, et. al., 2009) in assuming a 2.9 percent safe real rate of discount. We also find that the precise marketed assets used to price future Social Security benefits and taxes can significantly alter the estimate of the open group liability.

CRAIG COPELAND, Employee Benefit Research Institute (EBRI)
Email: COPELAND@EBRI.ORG

When predicting the future income security of retirees, researchers typically focus on measures concerned with retirees’ accumulated financial assets, particularly within tax-qualified retirement plans (e.g., 401(k) plans and individual retirement accounts (IRAs)), and coverage by supplemental health insurance to Medicare provided through a former employer. However, any debt that a near-elderly or elderly family has accrued going into retirement or during retirement is likely to offset its asset accumulations, resulting in a lower level of retirement income security. This paper focuses on the trends in debt levels among those age 55 and older who are approaching or are in retirement, as financial liabilities are a vital but often ignored component of retirement income security. The Federal Reserve’s Survey of Consumer Finances (SCF) is used to determine the level of debt in this paper. Debt is examined in two ways: 1) debt payments relative to income, and 2) debt relative to assets. Each measure provides some insight into the ability of these families to cover their debt before or during retirement. For example, higher debt-to-income ratios may be acceptable for younger families with long working careers ahead of them, since their incomes are likely to rise and their debt (related to housing or children) is likely to fall in the future. But a higher debt-to-income ratio may be more serious for older families, as they could be forced to reduce their accumulated assets to service the debt when their earning years are ending. However, if these high debt-to-income older families have low debt-to-asset ratios, the effect of paying off the debts may not be as financially difficult as it would be for those with high debt-to-income and debt-to-asset ratios.

As described in this paper, debt levels of the elderly and near-elderly are heading up: Among elderly families - and especially among the lower-income elderly - both housing debt and consumer debt levels are rising. For some cohorts, a significant percentage have debt levels well beyond the threshold considered problematic. Although rising debt levels are not necessarily a sign of danger for all elderly or near-elderly families (especially if they are also high-income), rising housing debt is of particular concern, since housing typically is the major asset elderly families have, and leveraging it at this point in their lives may leave them without a major resource to finance an adequate retirement, especially after the downturn in the housing market during 2008-2009.

The PDF for the above title, published in the October 2009 issue of EBRI Notes, also contains the full text of another October 2009 EBRI Notes article abstracted on SSRN: The Relationship Between Union Status and Employment-Based Health Benefits.

ANNAMARIA LUSARDI, Dartmouth College - Department of Economics, National Bureau of Economic Research (NBER)
Email: annamaria.lusardi@dartmouth.edu
OLIVIA S. MITCHELL, University of Pennsylvania - Insurance & Risk Management Department, National Bureau of Economic Research (NBER)
Email: mitchelo@wharton.upenn.edu
VILSA CURTO, National Bureau of Economic Research (NBER)
Email: vilsa.curto@post.harvard.edu

This paper analyzes new data on financial literacy and financial sophistication from the 2008 Health and Retirement Study. We show that financial literacy is lacking among older individuals and for the first time explore additional questions on financial sophistication which proves even scarcer. For this sample of older respondents over the age of 55, we find that people lack even a rudimentary understanding of stock and bond prices, risk diversification, portfolio choice, and investment fees. In view of the fact that individuals are increasingly required to take on responsibility for their own retirement security, this lack of knowledge has serious implications.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

LAWRENCE A. FROLIK, University of Pittsburgh - School of Law
Email: frolik@pitt.edu

America’s retirees are faced with a potential financial disaster. Economic security in retirement has long depended on Social Security, private savings and employer provided retirement plans. While much attention has been paid to the financial problems of Social Security and the lack of private saving for retirement, little attention has been paid to an alarming development in employer provided retirement plans: the likely inability of retirees during the long years of their retirement to successfully manage their retirement funds accumulated in 401(k) and similar accounts. We as a society have set up a funding system for retirement that assumes retirees will be able to successfully manage their IRAs for the 20 or 30 years of retirement. We know, however, that most will not. Some will lack the basic intelligence or knowledge of finance take on the risk, oversight and planning. Some will be fine managing an IRA at age 65, but lose the ability due to physical decline. Finally, millions of aging IRA owners will lose the ability to manage their finances because of the lost of mental capacity, primarily because of dementia. Asking individuals to husband a lump-sum payout from a 401(k) retirement account for the 20 to 30 years of retirement as they physically and mentally decline is a recipe for disaster. Unless we provide a more secure way to stretch retirement dollars into the twilight of retiree lives, we can expect to see more and more elderly retirees slide into poverty. The solution is to create federally guaranteed life-time annuities that retirees can purchase with the funds accumulated in their 401(k) retirement accounts.

CHRISTOPHER R. TAMBORINI, U.S. Social Security Administration
Email: Chris.Tamborini@ssa.gov
HOWARD IAMS, U.S. Social Security Administration
Email: Howard.m.iams@ssa.gov
KEVIN WHITMAN, U.S. Social Security Administration
Email: Kevin.Whitman@ssa.gov

Large-scale changes in American family structures over the past decades have important implications for the retirement experiences of women. In this study, the authors use a restricted-use file of the Marital History Module of the U.S. Census Bureau's Survey of Income and Program Participation to investigate changes in the marital histories of women aged 40 to 69 years between 1990 and 2004, with a focus on outcomes relevant for Social Security spouse and widow benefit eligibility. Multinomial and binary logistic regression analyses show significant changes in women's marital patterns since 1990, with more substantial shifts occurring among recent cohorts. Due to downward trends in marriage, the authors find a modest decline in Social Security spouse and widow benefit eligibility in 2004, particularly among Black women born toward the end of the baby boom generation.

HUGO BENITEZ-SILVA, SUNY at Stony Brook University, College of Arts and Science, Department of Economics
Email: hugo.benitez-silva@sunysb.edu
BERNA DEMIRALP, Old Dominion University - Economics
Email: bdemiral@odu.edu
ZHEN LIU, University at Buffalo, SUNY
Email: zl24@buffalo.edu

We build upon the growing literature on financial literacy, which studies the prevalence of lack of knowledge about various financial issues, and analyze how much people know about the Social Security rules using a small pilot survey conducted in 2007, and a follow-up and extended survey funded by MRRC conducted in December of 2008. We then assess the consequences of the apparent prevalence of lack of information by individuals about the rules governing the Social Security system using a realistic and empirically-based life-cycle model of retirement behavior under uncertainty. We investigate the individual’s retirement and savings decisions under incomplete information and unawareness, in which a portion of the population does not know some or all of the rules of the system. We compare the outcomes in these cases to the outcome under full information, computing the welfare gain resulting from the acquisition of information regarding the Social Security system. Our analysis can illuminate the need for policies that foster knowledge of the system, which can improve welfare, and can result in better policy outcomes.

ANDREW G. BIGGS, American Enterprise Institute
Email: andrew.biggs@aei.org

Due to falling prices, Social Security will make no cost-of-living adjustment (COLA) to retirement benefits in 2010. Retirees, who feel their benefits are too low and believe the prices they pay are rising, are up in arms. Newspaper headlines announce, "Millions face shrinking Social Security payments," and seniors' groups are already pressuring Congress to pass an ad hoc COLA this year. But most retirees do not know that "no COLA" can actually translate into big benefit increases. When falling prices coincide with stable benefits, purchasing power increases. Moreover, Medicare premium increases are limited in years in which no COLA is paid. Combined, the typical retiree will be better off by almost $725 this year. Paying a COLA this year is unnecessary and would boost the long-term Social Security deficit.