"What Replacement Rates Should Households Use?" 

Michigan Retirement Research Center Research Paper No. 2009-214

JOHN KARL SCHOLZ, University of Wisconsin - Madison - Department of Economics, National Bureau of Economic Research (NBER)
Email: Jkscholz@wisc.edu
ANANTH SESHADRI, University of Wisconsin - Madison - Department of Economics
Email: ASESHADR@SSC.WISC.EDU

Common financial planning advice calls for households to ensure that retirement income exceeds 70 percent of average pre-retirement income. We use an augmented life-cycle model of household behavior to examine optimal replacement rates for a representative set of retired American households. We relate optimal replacement rates to observable household characteristics and in doing so, make progress in developing a set of theory-based, but readily understandable financial guidelines. Our work should be a useful building block for efforts to assess the adequacy of retirement wealth preparation and efforts to promote financial literacy and well-being.

"Health Cost Risk and Optimal Retirement Provision: A Simple Rule for Annuity Demand" 

CentER Discussion Paper Series No. 2010-14

KIM PEIJNENBURG, Tilburg University, Netspar
Email: j.m.j.peijnenburg@uvt.nl
THEO NIJMAN, Tilburg University - Center and Faculty of Economics and Business Administration
Email: Nyman@uvt.nl
BAS J. M. WERKER, Tilburg University - Center for Economic Research (CentER)
Email: Werker@TilburgUniversity.nl

We analyze the effect of health cost risk on optimal annuity demand and consumption/savings decisions. Many retirees are exposed to sizeable out-of-pocket medical expenses, while annuities potentially impair the ability to get liquidity to cover these costs and smooth consumption. We find that if out-of-pocket medical expenses can already be very sizeable early in retirement, full annuitization is suboptimal. In other cases, individuals take advantage of the mortality credit annuities provide and save out of the annuity income to build a buffer for health cost shocks at later ages. When comparing to empirically observed levels of annuitization, we find that sizeable health cost risk early in retirement may resolve the annuity puzzle. Moreover, we explain the observed pattern of annuitization as a function of initial wealth at retirement. For personal financial planning purposes, we develop a simple rule of thumb for annuity demand, based on expected health cost risk early in retirement, wealth at retirement, and subsistence consumption levels. We show that the welfare costs from using the rule compared to the life cycle model are small.

"The Impact of Changing Earnings Volatility on Retirement Wealth" 

AUSTIN NICHOLS, The Urban Institute
Email: ANichols@ui.urban.org
MELISSA FAVREAULT, The Urban Institute
Email: MFAVREAU@UI.URBAN.ORG

Over the last several decades, the volatility of family income has increased markedly, and own earnings volatility has remained relatively flat. Volatility may affect retirement wealth, depending on whether volatility affects accrued pension contributions or withdrawals or earnings credited toward future Social Security benefits. This project assesses the effect of the volatility of individual and family earnings on asset accumulation and projected retirement wealth using survey data matched to administrative earnings records.

"Social Security, Benefit Claiming, and Labor Force Participation: A Quantitative General Equilibrium Approach" 

FRB of New York Staff Report No. 436

SELAHATTIN IMROHOROGLU, University of Southern California - Department of Finance and Business Economics
Email: selo@marshall.usc.edu
SAGIRI KITAO, University of Southern California - Department of Finance and Business Economics
Email: sagiri.kitao@gmail.com

We build a general equilibrium model of overlapping generations that incorporates endogenous saving, labor force participation, work hours, and Social Security benefit claims. Using this model, we study the impact of three Social Security reforms: 1) a reduction in benefits and payroll taxes; 2) an increase in the earliest retirement age, to sixty-four from sixty-two; and 3) an increase in the normal retirement age, to sixty-eight from sixty-six. We find that a 50 percent cut in the scope of the current system significantly raises asset holdings and the labor input, primarily through higher participation of older workers, and reduces the shortfall of the Social Security budget through a reduction in early claiming. Increasing the normal retirement age also raises saving and the labor supply, but the effects are smaller. Postponing the earliest retirement age has only a negligible effect. When the projected aging of the population is taken into account, the case for a reform that encourages labor force participation of the elderly appears to be much stronger.

"Financial Hardship Before and After Social Security's Early Eligibility Age" 

W. RICHARD JOHNSON, affiliation not provided to SSRN
Email: wrjohnson@cablelynx.com
GORDON MERMIN, affiliation not provided to SSRN
Email: merming@gao.gov

Although poverty rates for Americans ages 65 and older have plunged over the past half century, many people continue to fall into poverty in their late fifties and early sixties. This study examines financial hardship rates in the years before qualifying for Social Security retirement benefits at age 62 and investigates how the availability of Social Security improves economic well-being at later ages. The analysis follows a sample of adults from the 1937-39 birth cohort for 14 years, tracking their employment, disability status, and income as they age from their early 50s until their late 60s. It measures the share of older adults who appear to have been forced into retirement by health or employment shocks and the apparent impact of involuntary retirement on low-income rates. The study also estimates models of the likelihood that older adults experience financial hardship before reaching Social Security’s early eligibility age.

The results show that the likelihood of experiencing financial hardship increases significantly as people approach Social Security’s early eligibility age. The increase in hardship rates is concentrated among workers with limited education and health problems. For example, among those who did not complete high school, hardship rates increase from 23 percent at ages 52 to 54 to 31 percent at ages 60 to 61, a relative increase of 36 percent. Hardship rates decline after age 62, when most people qualify for Social Security retirement benefits. These findings highlight the fragility of the income support system for Americans in their fifties and early sixties.

"Rising Tides and Retirement: The Aggregate and Distributional Effects of Differential Wage Growth on Social Security" 

MELISSA FAVREAULT, The Urban Institute
Email: MFAVREAU@UI.URBAN.ORG

Recent growth in wage inequality has important implications for Social Security solvency and the distribution of benefits. Because only earnings below the taxable maximum are subject to Social Security payroll taxes, wage growth that is concentrated among very high earners will generate lower tax receipts than wage growth that is more evenly distributed. The progressivity of the Social Security benefit formula increases benefit payouts when the share of workers with low wages grows. This study uses a dynamic microsimulation model to examine the aggregate and distributional consequences of alternative scenarios about the distribution of future wage growth among workers. We find fairly marked changes in projected Social Security benefit distributions, poverty, and long-term financing status with relatively modest changes in assumptions about wage differentials.

"How Seniors Change Their Asset Holdings During Retirement" 

MAURICIO SOTO, International Monetary Fund (IMF)
Email: mauricio.soto.1@bc.edu
RUDOLPH PENNER, Urban Institute
Email: rpenner@ui.urban.org
KAREN E. SMITH, Urban Institute
Email: ksmith@ui.urban.org

We use the 1998-2006 waves of the Health and Retirement Study (HRS) to investigate how households change their asset holdings at older ages. We find a notable increase in the net worth of older households between 1998 and 2006, with most of the growth due to housing. Our results indicate that, through 2006, older households did not spend all of their capital gains. This asset accumulation provides older households with a financial cushion for the turbulence experienced after 2007. The wealth distribution is highly skewed, and the age patterns of asset accumulation and decumulation vary considerably by income group. High-income seniors increase assets at older ages. Middle-income seniors reduce their assets in retirement, but at a rate that for most seniors will not deplete assets within their expected life. Many low-income seniors accumulate fewer assets and spend their financial assets at a rate that will mostly deplete them at older ages, leaving low-income seniors with only Social Security and DB pension income at older ages.

"The Role of Information for Retirement Behavior: Evidence Based on the Stepwise Introduction of the Social Security Statement" 

GIOVANNI MASTROBUONI, Collegio Carlo Alberto, Center for Research on Pensions and Welfare Policies (CeRP), Netspar
Email: giovanni.mastrobuoni@carloalberto.org

In 1995, the Social Security Administration started sending out the annual Social Security Statement. It contains information about the worker’s estimated benefits at the ages 62, 65, and 70. I use this unique natural experiment to analyze the retirement and claiming decision-making. First, I find that, despite the previous availability of information, the Statement has a significant impact on workers’ knowledge about their benefits. These findings are consistent with a model where workers need to gather costly information in order to improve their retirement decision. Second, I use this exogenous variation in knowledge to analyze the optimality of workers’ decisions. Several findings suggest that workers do not change their retirement behavior: i) Workers do not change their expected age of retirement after receiving the Statement; ii) monthly claiming patterns do not show any change after the introduction of the Social Security Statement; iii) workers do not become more sensitive to Social Security incentives after receiving the Statement. Either, workers are already behaving optimally, or the information contained in the Statement is not sufficient to improve their retirement behavior.

"Work Ability and the Social Insurance Safety Net in the Years Prior to Retirement" 

W. RICHARD JOHNSON, affiliation not provided to SSRN
Email: wrjohnson@cablelynx.com
MELISSA FAVREAULT, The Urban Institute
Email: MFAVREAU@UI.URBAN.ORG

A patchwork of public programs - primarily Social Security Disability Insurance (DI), workers’ compensation, Supplemental Security Income (SSI), and veterans’ benefits - provides income supports to people unable to work. Yet, questions persist about the effectiveness of these programs. This report examines the economic consequences of disability for a sample of Americans observed from age 51 to 64. The results underscore the precarious financial state for most people approaching traditional retirement age with disabilities. Disability rates roughly double from age 55 to 64. Fewer than half who meet our disability criteria ever receive disability benefits in their fifties or early sixties. Benefit receipt rates are much higher among those with the most severe disabilities, suggesting that benefits are targeted to those least able to work. However, even when models control for disability severity, women are less likely than men to receive benefits. Those with cancer and heart problem diagnoses are more likely to receive DI, suggesting that DI favors workers with certain medical diagnoses. Poverty rates for people who collect disability benefits in their fifties and early sixties more than triple following benefit receipt.

"Retirement and Social Security: A Time Series Approach" 

BRENDAN CUSHING-DANIELS, Gettysburg College
Email: bdaniels@gettysburg.edu
C. EUGENE STEUERLE, Urban Institute
Email: esteuerl@ui.urban.org

Traditional analyses of retirement decisions focus on the age, from birth, of the individual making choices about how much to work, consume, and save for old age. However, remaining life expectancy is arguably a better way of examining these issues. As mortality rates decline, people at a given age now have more remaining years of life expectancy than they did in the past. If participation rates at older ages remain constant (or decline), then average time spent in retirement will increase. Additionally, because health status and mortality are correlated, adults with more expected years of life are generally in better health (and better able to work) than those with fewer years of remaining life.

This paper examines labor force participation rates of older workers considering both chronological age and remaining life expectancy. Results show that participation by remaining life expectancy declines for men through the early 1990s, leveling off in the next decade. However, participation by age has been rising for men in their sixties since the mid-1990s. Whether we specify the empirical model by age or by remaining life expectancy, ages 62 and 65 both have strong negative effects on participation, confirming a major role in retirement decisions for Social Security. Finally, we find that controlling for other factors – education, marital status, and business cycle effects – magnifies the decline in participation attributable to cohort effects for men born between 1900 and 1960, but reduces the importance of cohort effects for women born in these years.

"How Much do Households Really Lose by Claiming Social Security at Age 62?" 

WEI SUN, Boston College
Email: wei.sun@bc.edu
ANTHONY WEBB, Boston College - Center for Retirement Research
Email: webbaa@bc.edu

Individuals can claim Social Security at any age from 62 to 70 although most claim at 62 or soon thereafter. Those who delay claiming receive increases that are approximately actuarially fair. We show that expected present value calculations substantially understate both the optimal claim age and the losses resulting from early claiming because they ignore the value of the additional longevity insurance acquired as a result of delay. Using numerical optimization techniques, we illustrate that for plausible preference parameters, the optimal age for non-liquidity constrained single individuals and married men to claim benefit is between 67 and 70. We calculate that Social Security Equivalent Income, the amount by which benefits payable at suboptimal ages must be increased so that a household is indifferent between claiming at those ages and the optimal combination of ages, can be as high as 19.0 percent.