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This paper investigates whether exchanging the Social Security delayed retirement credit, currently paid as an increase in lifetime annuity benefits, for a lump sum would induce later claiming and additional work. We show that people would voluntarily claim about half a year later if the lump sum were paid for claiming any time after the Early Retirement Age, and about two-thirds of a year later if the lump sum were paid only for those claiming after their Full Retirement Age. Overall, people will work one-third to one-half of the additional months, compared to the status quo. Those who would currently claim at the youngest ages are likely to be most responsive to the offer of a lump sum benefit.
We investigate the theoretical impact of including two empirically-grounded insights in a dynamic life cycle portfolio choice model. The first is to recognize that, when managing their own financial wealth, investors incur opportunity costs in terms of current and future human capital accumulation, particularly if human capital is acquired via learning by doing. The second is that we incorporate age-varying efficiency patterns in financial decisionmaking. Both enhancements produce inactivity in portfolio adjustment patterns consistent with empirical evidence. We also analyze individuals’ optimal choice between self-managing their wealth versus delegating the task to a financial advisor. Delegation proves most valuable to the young and the old. Our calibrated model quantifies welfare gains from including investment time and money costs, as well as delegation, in a life cycle setting.
The paper discusses an additional reform proposal for enhancing Social Security solvency which reframes the existing debate in a different light. In our research, we focus on incentives to prolong working years and to delay benefits claiming as a way of sustaining Social Security. Specifically, we analyze how the offer of a budget-neutral, actuarially fair lump sum payment - instead of the current delayed retirement credit – would encourage people to delay claiming their OASI benefits and work longer. The results of our research will be useful for policymakers, namely in (1) measuring who would delay claiming benefits if offered a lump sum instead of higher annuity payments, (2) examining how long they would wait, and (3) how much longer, if at all, they would continue working in the interim.
Many people do not understand the concepts of life expectancy and longevity risk, potentially leading them to under-save for retirement or to not purchase longevity insurance, which in turn could reduce wellbeing at older ages. We investigate alternative ways to increase the salience of both concepts, allowing us to assess whether these change peoples’ perceptions and financial decision making. Using randomly-assigned vignettes providing subjects with information about either life expectancy or longevity, we show that merely prompting people to think about financial decisions changes their perceptions regarding subjective survival probabilities. Moreover, this information also boosts respondents’ interest in saving and demand for longevity insurance. In particular, longevity information influences both subjective survival probabilities and financial decisions, while life expectancy information influences only annuity choices. We provide some evidence that many people are simply unaware of longevity risk.
Target date funds in corporate retirement plans grew from $5B in 2000 to $734B in 2018, partly because federal regulation sanctioned these as default investments in automatic enrollment plans. We show that adopters delegated pension investment decisions to fund managers selected by plan sponsors. Including these funds in retirement saving menus raised equity shares, boosted bond exposures, curtailed cash/company stock holdings, and reduced idiosyncratic risk. The adoption of low-cost target date funds may enhance retirement wealth by as much as 50 percent over a 30-year horizon.
The growth and popularity of defined contribution pensions, along with the government’s increasing attention to retirement plan costs and investment choices provided, make it important to understand how people select their retirement plan investments. This paper shows how employees in a large firm altered their fund allocations when the employer streamlined its pension fund menu and deleted nearly half of the offered funds. Using administrative data, we examine the changes in plan participant investment choices that resulted from the streamlining and how these changes might affect participants’ eventual retirement wellbeing. We show that streamlined participants’ new allocations exhibited significantly lower within-fund turnover rates and expense ratios, and we estimate this could lead to aggregate savings for these participants over a 20-year period of $20.2M, or in excess of $9,400 per participant. Moreover, after the reform, streamlined participants’ portfolios held significantly less equity and exhibited significantly lower risks by way of reduced exposures to most systematic risk factors, compared to their non-streamlined counterparts.
A recent US Treasury regulation allowed deferred longevity income annuities to be included in pension plan menus as a default payout solution, yet little research has investigated whether more people should convert some of the $15 trillion they hold in employer-based defined contribution plans into lifelong income streams. We investigate this innovation using a calibrated lifecycle consumption and portfolio choice model embodying realistic institutional considerations. Our welfare analysis shows that defaulting a small portion of retirees’ 401(k) assets (over a threshold) is an attractive way to enhance retirement security, enhancing welfare by up to 20% of retiree plan accruals.
Most defined contribution pension plans pay benefits as lump sums, yet the US Treasury has recently encouraged firms to protect retirees from outliving their assets by converting a portion of their plan balances into longevity income annuities (LIA). These are deferred annuities which initiate payouts not later than age 85 and continue for life, and they provide an effective way to hedge systematic (individual) longevity risk for a relatively low price. Using a life cycle portfolio framework, we measure the welfare improvements from including LIAs in the menu of plan payout choices, accounting for mortality heterogeneity by education and sex. We find that introducing a longevity income annuity to the plan menu is attractive for most DC plan participants who optimally commit 8-15% of their plan balances at age 65 to a LIA that starts paying out at age 85. Optimal annuitization boosts welfare by 5-20% of average retirement plan accruals at age 66 (assuming average mortality rates), compared to not having access to the LIA. We also compare the optimal LIA allocation versus two default options that plan sponsors could implement. We conclude that an approach where a fixed fraction over a dollar threshold is invested in LIAs will be preferred by most to the status quo, while enhancing welfare for the majority of workers.
Many older US households have done little or no planning for retirement, and there is a substantial population that seems to undersave for retirement. Of particular concern is the relative position of older women, who are more vulnerable to old-age poverty due to their longer longevity. This paper uses data from a special module we devised on planning and financial literacy in the 2004 Health and Retirement Study. It shows that women display much lower levels of financial literacy than the older population as a whole. In addition, women who are less financially literate are also less likely to plan for retirement and be successful planners. These findings have important implications for policy and for programs aimed at fostering financial security at older ages.
Many Americans claim Social Security benefits early, though this leaves them with lower benefits throughout retirement. We build a lifecycle model that closely tracks claiming patterns under current rules, and we use it to predict claiming delays if, by delaying benefits, people received a lump sum instead of an annuity. We predict that current early claimers would defer claiming by a year given actuarially fair lump sums, and the predictions conform with respondents’ answers to a strategic survey about the lump sum. In other words, such a reform could provide an avenue for encouraging delayed retirement without benefit cuts or tax increases. Moreover, many people would still defer claiming even for smaller lump sums.