The economics of aging.

• Author: Wise, David A.
• Position: Program Report

Population aging, early retirement, limited but increasing retirement saving, more expensive medical practice patterns, and an established national entitlement to income and health care support after age 65--all of these factors largely define the economic environment of the United States (and much of the world) at the beginning of the 21st century. Over the past 30 years, life expectancy has increased from age 71 to age 77, while the most common age of retirement has decreased from age 65 to age 62. Retiring at age 62, the typical American retiree today faces another 20 years of living, consuming and, at one time or another, and in many cases regularly, needing expensive health care services. These trends already have placed significant financial pressure on the public and employer-sponsored programs that provide income and health care support to older Americans.

Meanwhile, the massive demographic bulge in the population--the baby boom generation--begins turning age 62 in 2008. Going forward, the number of Americans age 62 and older is projected to double from 40 million today to 80 million 30 years from now, while the working age population is projected to grow by just 12 percent over the same period. Compounding the demographic situation is the continuing rise in medical costs. National health care expenditures have grown from $250 billion annually in 1980 to $1.4 trillion today, and show little sign of slowing down. The combination of economic, labor market, health and demographic trends points to any number of social and economic challenges in the decades ahead. Understanding the complexities of this situation, and the relationships between demographics, policy, behavior, economics, and health--this is the substantive aim of the NBER Program on the Economics of Aging.

Begun in 1986, the Aging Program has developed primarily around large, coordinated research projects that simultaneously address several interrelated issues in the economics of aging. Extensive funding for the program has been provided by the National Institute on Aging (NIA), both through multiple research grants and through a Center grant, which provides centralized infrastructure support to the program effort. NIA also has supported our efforts to engage new investigators in studying issues in aging, and at least a dozen graduate students and post-doctoral research fellows become engaged in the program each year through NIA fellowships. Many more become engaged as research assistants on project grants. A number of smaller "exploratory" projects on issues in aging are supported through the Center, as well as projects that integrate related components of the overall research effort. More than 100 papers are completed annually by participants in the NBER program. Some of these also appear in a series of books published by the University of Chicago Press. (1)

The Economic Circumstances of Older Americans

Personal Retirement Accounts

A major theme of the Aging Program since its inception has been to better understand the economic circumstances of older Americans. A key fact from early project work was the very small amount of financial assets of most retirees in the United States in the early 1980s and the overwhelming reliance on Social Security, and in some cases firm pension plans, for financial support in retirement. But over the last two decades, there has been a dramatic transformation in the magnitude of saving that is taking place in personal retirement accounts, such as IRAs and 401(k) plans. Now about 85 percent of contributions to retirement plans are to personal accounts. In decomposing trends in plan eligibility, participation given eligibility, participant contributions, and aggregate wealth accumulation in personal retirement accounts, and in projecting the future of these trends, James M. Poterba, Steven F. Venti and I have confirmed the potential of 401(k) plans to significantly alter the financial circumstances of individuals retiring in the future [W8610, W6295, W5762]. Because more individuals will have had more years of participation in 401(k)-type savings plans, they will reach retirement with increasing accumulations of financial assets. For many, their personal retirement accounts will contribute as much or more in retirement than Social Security. The most recent in a long series of studies on this topic shows that the ratio of retirement plan assets to wage and salary earnings has grown more than five fold since 1975. This represents a fundamental transition in the composition of post-retirement financial support in the United States.

Despite these aggregate trends, it's clear that there is wide variation in saving behavior across the population. For example, Venti and I have found that saving rates vary substantially at all income levels, and that these variations lead to vastly different levels of asset accumulation over a working career [W7521]. What explains this variation in behavior? Part of the answer is simply choice: some people choose to save a lot, and others do not. But that choice is made in the context of one's social and economic environment, as well as the public and employer policies that relate to individual saving decisions. In a series of studies, James Choi, David Laibson, Brigitte Madrian, Andrew Metrick, and Dennis G. Shea find that the "default" provisions of 401(k) plans make a huge difference in whether and how much people save in their 401(k) plans [W8655, W8651, W7682]. Many more employees participate when there is automatic enrollment; and they contribute more to their plans, on average, when the default contribution rate of the program is higher. Recent research by Esther Duflo and Emmanuel Saez provides complementary evidence of increased participation in retirement plans by individuals who received a financial incentive to attend a program information session, as well as by individuals who did not receive the incentive, but who worked in departments where others received the incentive [W8885, W7735]. Thus the influence of peer behavior was found to be a significant factor in plan participation decisions.

Related studies from the Aging Program have considered more specific aspects of retirement saving. Studies of pre-retirement withdrawals from 401(k) plans find little effect on the total dollar accumulations in these plans, as a large fraction of job changers don't withdraw assets from their personal accounts and a large fraction of assets that are withdrawn are "rolled over" into other personal retirement accounts [W7314]. Studies of whether the assets in retirement accounts have replaced saving that would have otherwise taken place in other forms conclude that the large majority of personal retirement saving is new saving that would not have occurred without these plans [W5599]. Studies of the potential offsetting decline in defined benefit pension plan coverage conclude that the growth of personal retirement accounts dwarfs any displacement of assets in traditional plans [W8610]. And, studies of alternative measures of saving emphasize the implications of not counting capital gains as part of saving in the NIPA personal saving rate, while the expenditure of money that has accumulated in the form of capital gains is still counted as dis-saving (or spending) [W8237, W8610]. As a result, the NIPA-measured saving rate can be very low--about 2 percent now--while the retirement plan contribution rate (as a percentage of wage and salary earnings) has been over 8 percent.

Looking ahead, our research agenda has evolved to focus on the risks associated with different forms of retirement saving, and how recent trends may have changed the risk exposure of individuals in providing for their retirement. The different risk characteristics of fixed assets (like 401(k) accounts), as compared with annuitized assets (like Social Security and traditional pension plans) is one piece of this work. Another is the increased exposure to market fluctuations that is associated with personal retirement accounts. The extreme case of company stock as a retirement investment has been explored recently by Olivia S. Mitchell and Stephen P. Utkus; they confirm the risk of such investments, and identify policy tools that might encourage greater diversification [W9250]. Poterba, with various coauthors, also has looked at the allocation of investments in personal retirement accounts, focusing particularly on the mix between debt and equity holdings [W9268, W7991, W7392]. Among other findings, his research shows that the aggregate allocation between stocks and bonds in individual accounts is broadly similar to the allocation one finds in defined benefit plans, which are managed by financial professionals. But there is much more variation across individual retirement accounts. For instance, just over 45 percent of households with tax-deferred accounts appear to hold only equities, and 22 percent hold only debt. These results provide a starting point from which to consider the market risk of personal accounts.

Social Security, Housing, Annuities, and Bequests

As the primary source of retirement income support in the United States, Social Security defines the economic circumstances of many older Americans. Many members of the Aging Program are engaged in analyses of Social Security, as well as on the potential design and implications of various Social Security reform possibilities. In this report, I have focused on projects supported by the National Institute on Aging as part of NIA research grants. One such project, directed by Jeffrey B. Liebman, looks at how alternative Social Security reforms would be likely to affect lower-income households. Social Security is widely recognized as a redistributive program, replacing a greater fraction of earnings for those at lower income levels. Liebman's research, however, points to many other redistributive aspects of Social Security--from people with shorter life...