Lecture 2: The Changing U'S' Retirement Landscape

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Lecture 2 The Changing U.S. Retirement Landscape

• Monday, August 28 2006

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By the end of this lecture, you should be able to

• Explain why retirement income has become major
  issue in private and public sector
• Describe current sources of income for the
  elderly
• Describe major trends facing retirement landscape
  in the US
• Discuss rationale for public concern over
  pensions
• Explain why employers might offer pensions out of
  self-interest

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Demographic Shifts

• Life expectancy (at birth)
• 1900 male 51.5, female 58.3
• 2000 male 79.6, female 84.3
• Fertility declines
• Work patterns
• In 1900, 2/3 of those who reached 65 continued
  working
• Today, only 1/8 continue working after 65
• Living arrangements
• Nearly 3 out of 4 retired men in 1900 lived with
  adult children
• Today, fewer than 1 in 5 do

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Source Fast Facts Figures about Social
Security, August 2004
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Social Security Act of 1935

• Social Security as a national retirement system
• Championed by FDR to offer some measure of
  protection to the average citizen and to his
  family against poverty ridden old age
• Backdrop high unemployment (25 in 1932) and
  stock market crash of 1929

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Social Security Today

• In 2005, more than 48 million Americans will
  receive approx. 518 billion in benefits
• Approx 40 million of these are retirees, or their
  dependents and survivors (rest is for DI)
• More than 9 of every 10 individuals over age 65
  receive SS benefits
• About 2/3 of elderly receive 50 or more of their
  income from Social Security
• SS is the only source of income for 22 of elderly

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Employer Sponsored Pensions

• Largely gained popularity in post WWII period
  often driven by unionization
• Savings accumulated in employer plans is growing
  fast
• 1.6 trillion in 1985
• 5.5 trillion in 2003
• Pronounced shift away from defined benefit to
  defined contribution plans
• Much more to come on this topic!

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Individual Savings

• Accounts for 15 of all retirement income, but is
  highly skewed
• More than half of households report income from
  assets, but many have none
• Line between personal saving and pension saving
  is getting increasingly blurry

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Labor Earnings

• In 1962, 36 of households age 55 received labor
  earnings
• In 2002, only 22 do
• Choosing retirement date is an important
  adjustment mechanism for those who have over- or
  under-saved
• Ability to contribute to workforce much greater
  today
• Better health than elderly of 50 years ago
• Job skills not as tied to physical prowess

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Public Assistance

• Programs such as SSI (Supplemental Security
  Income)
• 5 of elderly households receive some form of
  public assistance
• For 25 of recipients, it is sole source of income

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What are the Big Trends?

• Continued aging of the population
• Shift towards more self reliance
• DB to DC
• Debate over personal accounts
• Rising health care costs

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Population Aging

• Ratio of individuals age 20 64 to individuals
  age 65
• 1950 gt7
• 1975 5.3
• 2000 4.8
• 2025 3.3
• Today, 1 in 8 citizens is age 65
• By 2050, 1 in 5 will be age 65

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DB vs. DC Plans

• Defined Benefit
• Defined Contribution

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The Shift from DB to DC

• 1980 38 million DB participant
• 20 million DC participants
• 1999 41 million DB participants
• 60 million DC participants
• Source U.S. DOL Private Pension Plan Bulletin

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Health Care

• U.S. spent 14.1 of GDP on health care in 2001,
  or about 1.4 trillion
• Up from 8.8 of GDP in 1980
• Likely to reach 16 by 2010
• Growth in costs expected to accelerate some
  estimates that it will be 38 of GDP in the
  long-run!!!
• Disproportionately large fraction of health care
  expenditures incurred by the elderly

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A Model of Individual Retirement Savings Behavior

• The Life Cycle Model
• Individuals like to smooth consumption over their
  lifetime
• But income is not even over lifetime
• What do you do?

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A Simplified Life Cycle Model

Income
save
Consumption
borrow
Spend down wealth
Age 62
Age 22
death
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A Simplified Life Cycle Model

Income
save
Consumption
borrow
Spend down wealth
Age 62
Age 22
death
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The Rational Case Against Public and Private
Pensions

• If individuals were behaving rationally and with
  perfect foresight, they should be saving enough
  today to take care of their retirement
• Attempts to force savings through public or
  private pensions will be
• At best, redundant and unnecessary
• At worst, harmful, by making people save too
  much, etc.

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The Case for Public Support of Retirement Pensions

• Inadequate foresight or planning
• Uncertainty and imperfect insurance markets
• How long will I live?
• What will my expenditure needs be?
• Income Redistribution

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The Value of Pensions to Employers

• Tax deferral
• The three Rs
• Recruiting
• May help sort out type of applicant that you
  want
• Retention
• Vesting rules, back-loaded compensation plans
• Retirement
• Influence choice of retirement date
• Encourage Productivity
• Discourage collective bargaining