CFS working paper series
https://gfk-cfs.de/working-papers/
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2011, 23
The direct financial impact of the financial crisis has been to deal a heavy blow to investment-based pensions; many workers lost a substantial portion of their retirement saving. The financial sector implosion produced an economic crisis for the rest of the economy via high unemployment and reduced labor earnings, which reduced household contributions to Social Security and some private pensions. Our research asks which types of individuals were most affected by these dual financial and economic shocks, and it also explores how people may react by changing their consumption, saving and investment, work and retirement, and annuitization decisions. We do so with a realistically calibrated lifecycle framework allowing for time-varying investment opportunities and countercyclical risky labor income dynamics. We show that households near retirement will reduce both short- and long-term consumption, boost work effort, and defer retirement. Younger cohorts will initially reduce their work hours, consumption, saving, and equity exposure; later in life, they will work more, retire later, consume less, invest more in stocks, save more, and reduce their demand for private annuities. Keywords: Financial Crisis , Household Finance , Cycle Portfolio Choice , Labor Supply Classification: D1, G11, G23, G35, J14, J26, J32
2004, 01
How might retirees consider deploying the retirement assets accumulated in a defined contribution pension plan? One possibility would be to purchase an immediate annuity. Another approach, called the "phased withdrawal" strategy in the literature, would have the retiree invest his funds and then withdraw some portion of the account annually. Using this second tactic, the withdrawal rate might be determined according to a fixed benefit level payable until the retiree dies or the funds run out, or it could be set using a variable formula, where the retiree withdraws funds according to a rule linked to life expectancy. Using a range of data consistent with the German experience, we evaluate several alternative designs for phased withdrawal strategies, allowing for endogenous asset allocation patterns, and also allowing the worker to make decisions both about when to retire and when to switch to an annuity. We show that one particular phased withdrawal rule is appealing since it offers relatively low expected shortfall risk, good expected payouts for the retiree during his life, and some bequest potential for the heirs. We also find that unisex mortality tables if used for annuity pricing can make women's expected shortfalls higher, expected benefits higher, and bequests lower under a phased withdrawal program. Finally, we show that delayed annuitization can be appealing since it provides higher expected benefits with lower expected shortfalls, at the cost of somewhat lower anticipated bequests. Klassifikation: G22, G23, J26, J32, H55 . January 2004.
630
Over the life-cycle, wealth holdings tend to be highest in the early part of retirement. The quality of financial decisions among older adults is therefore an important determinant of their financial security during the asset drawdown phase. This paper assesses how financial literacy shapes financial decision-making at older ages. We devised a special module in the Singapore Life Panel survey to measure financial literacy to study its relationship with three aspects of household financial and investment behaviors: credit card debt repayment, stock market participation, and adherence to age-based investment glide paths. We found that the majority of respondents age 50+ has some grasp of concepts such as interest compounding and inflation, but fewer know about risk diversification. We provide evidence of a statistically significant positive association between financial literacy and each of the three aspects of suboptimal financial decision-making, controlling for many other factors, including education. A one-unit increase in the financial literacy score was associated with an 8.3 percentage point greater propensity to hold stocks, and a 1.7 percentage point higher likelihood of following an age-appropriate investment glide path. The financial literacy score is only weakly positively linked with timely credit card balance repayment, both in terms of statistical significance and estimate size.
607
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.
No. 684
This paper investigates retirees’ optimal purchases of fixed and variable longevity income annuities using their defined contribution (DC) plan assets and given their expected Social Security benefits. As an alternative, we also evaluate using plan assets to boost Social Security benefits through delayed claiming. We determine that including deferred income annuities in DC accounts is welfare enhancing for all sex/education groups examined. We also show that providing access to well-designed variable deferred annuities with some equity exposure further enhances retiree wellbeing, compared to having access only to fixed annuities. Nevertheless, for the least educated, delaying claiming Social Security is preferred, whereas the most educated benefit more from using accumulated DC plan assets to purchase deferred annuities.
2007, 21
Retirees confront the difficult problem of how to manage their money in retirement so as to not outlive their funds while continuing to invest in capital markets. We posit a dynamic utility maximizer who makes both asset location and allocation decisions when managing her retirement financial wealth and annuities, and we prove that she can benefit from both the equity premium and longevity insurance in her retirement portfolio. Even without bequests, she will not fully annuitize; rather, her optimal stock allocation amounts initially to more than half of her financial wealth and declines with age. Welfare gains from this strategy can amount to 40 percent of financial wealth (depending on risk parameters and other resources). In practice, it turns out that many retirees will do almost as well by purchasing a variable annuity invested 60/40 in stocks/bonds. JEL Classification: G11, G23, G22, D14, J26, H55
2013, 07
Household decisions are profoundly shaped by a complex set of financial options due to Social Security rules determining retirement, spousal, and survivor benefits, along with benefit adjustments that vary with the age at which these are claimed. These rules influence optimal household asset allocation, insurance, and work decisions, given life cycle demographic shocks such as marriage, divorce, and children. Our model generates a wealth profile and a low and stable equity fraction consistent with empirical evidence. We also confirm predictions that wives will claim retirement benefits earlier than husbands, while life insurance is mainly purchased by younger men. Our policy simulations imply that eliminating survivor benefits would sharply reduce claiming differences by sex while dramatically increasing men’s life insurance purchases.
573
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.
2013, 08
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.
2010, 11
How ordinary consumers make complex economic decisions: financial literacy and retirement readiness
(2010)
This paper explores who is financially literate, whether people accurately perceive their own economic decision-making skills, and where these skills come from. Self-assessed and objective measures of financial literacy can be linked to consumers’ efforts to plan for retirement in the American Life Panel, and causal relationships with retirement planning examined by exploiting information about respondent financial knowledge acquired in school. Results show that those with more advanced financial knowledge are those more likely to be retirement-ready.
2007, 33
The present paper introduces a new dataset, the Rand American Life Panel (ALP), which offers several appealing features for an analysis of financial literacy and retirement planning. It allows us to evaluate financial knowledge during workers’ prime earning years when they are making key financial decisions, and it offers detailed financial literacy and retirement planning questions, permitting a finer assessment of respondents’ financial literacy than heretofore feasible. We can also compare respondents’ self-assessed financial knowledge levels with objective measures of financial literacy, and most valuably, we can investigate prior financial training which permits us to identify key causal links. By every measure, and in every sample we examine, financial literacy proves to be a key determinant of retirement planning. We also find that respondent literacy is higher when they were exposed to economics in school and to company-based financial education programs. JEL Classification: D91
2007, 15
Economists are beginning to investigate the causes and consequences of financial illiteracy to better understand why retirement planning is lacking and why so many households arrive close to retirement with little or no wealth. Our review reveals that many households are unfamiliar with even the most basic economic concepts needed to make saving and investment decisions. Such financial illiteracy is widespread: the young and older people in the United States and other countries appear woefully under-informed about basic financial concepts, with serious implications for saving, retirement planning, mortgages, and other decisions. In response, governments and several nonprofit organizations have undertaken initiatives to enhance financial literacy. The experience of other countries, including a saving campaign in Japan as well as the Swedish pension privatization program, offers insights into possible roles for financial literacy and saving programs. JEL Classification: D80, D91, G11
2008, 03
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.
2006, 20
Baby boomer retirement security: the roles of planning, financial literacy and housing wealth
(2006)
We compare wealth holdings across two cohorts of the Health and Retirement Study: the early Baby Boomers in 2004, and individuals in the same age group in 1992. Levels and patterns of total net worth have changed relatively little over time, though Boomers rely more on housing equity than their predecessors. Most important, planners in both cohorts arrive close to retirement with much higher wealth levels and display higher financial literacy than non-planners. Instrumental variables estimates show that planning behavior can explain the differences in savings and why some people arrive close to retirement with very little or no wealth. Klassifizierung: D91, E21
2010, 09
We examined financial literacy among the young using the most recent wave of the 1997 National Longitudinal Survey of Youth. We showed that financial literacy is low; fewer than one-third of young adults possess basic knowledge of interest rates, inflation, and risk diversification. Financial literacy was strongly related to sociodemographic characteristics and family financial sophistication. Specifically, a college-educated male whose parents had stocks and retirement savings was about 45 percentage points more likely to know about risk diversification than a female with less than a high school education whose parents were not wealthy. These findings have implications for consumer policy. JEL Classification: D91
2012, 08
This paper examines data on financial sophistication among the U.S. older population, using a special-purpose module implemented in the Health and Retirement Study. We show that financial sophistication is deficient for older respondents (aged 55+). Specifically, many in this group lack a basic grasp of asset pricing, risk diversification, portfolio choice, and investment fees. Subpopulations with particular deficits include women, the least educated, persons over the age of 75, and non-Whites. In view of the fact that people are increasingly being asked to take on responsibility for their own retirement security, such lack of knowledge can have serious implications.
574
We analyze older individuals’ debt and financial vulnerability using data from the Health and Retirement Study (HRS) and the National Financial Capability Study (NFCS). Specifically, in the HRS we examine three different cohorts (individuals age 56–61) in 1992, 2004, and 2010 to evaluate cross-cohort changes in debt over time. We also use two waves of the NFCS (2012 and 2015) to gain additional insights into debt management and older individuals’ capacity to shield themselves against shocks. We show that recent cohorts have taken on more debt and face more financial insecurity, mostly due to having purchased more expensive homes with smaller down payments.
631
We analyze debt and debt management of Americans nearing retirement age. We show that older people have numerous financial obligations that can lead to financial distress. Using data from the 2015 National Financial Capability Study and an extensive literature review, we show that lack of financial literacy, lack of information, and behavioral biases help explain the prevalence of debt later in life. Our evidence indicates that debt at older ages can negatively influence retirement well-being.
629
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.
518
This chapter outlines the conditions under which accounting-based smoothing can be beneficial for policyholders who hold with-profit or participating payout life annuities (PLAs). We use a realistically-calibrated model of PLAs to explore how alternative accounting techniques influence policyholder welfare as well as insurer profitability and stability. We find that accounting smoothing of participating life annuities is favorable to consumers and insurers, as it mitigates the impact of short-term volatility and enhances the utility of these long-term annuity contracts.
644
In the wake of the global pandemic known as COVID-19, retirees, along with those hoping to retire someday, have been shocked into a new awareness of the need for better risk management tools to handle longevity and aging. This paper offers an assessment of the status quo prior to the spread of the coronavirus, evaluates how retirement systems are faring in the wake of the shock. Next we examine insurance and financial market products that may render retirement systems more resilient for the world’s aging population. Finally, potential roles for policymakers are evaluated.
662
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.