Adequacy of Saving for Old-Age in Europe
Discussion by Michael Hurd
Topic most developed in U.S.
• Data
• But more interesting topic in U.S. because of greater dependence on savings and private pensions
• If public pension is sole source of financing, debate is whether pensions are large enough.
Popular press and some research
• “Baby-boomers headed for poverty in retirement!”
• “60% not adequately prepared!”
• “Need $2M in retirement assets!”
• Etc.
Yet..
• Current retired doing fine
• Cohort studies show improvements (or at least not getting worse)
• Age 51-56 in 1992
• Age 51-56 in 2004 at least as well off as measured by saving plus pension wealth
What is going on?
How to think about problem?
Two persons with different lifetime earnings
Should have different levels of economic resources in retirement...which one “more adequate”
Comparison requires comparing economic resources with lifetime earnings for each person
Most common comparison
Income replacement rate
Income at retirement relative to income before retirement
Simple case• r = 0• annuitization so that consumption = income after
retirement
earnings
annuity
consumption
replacement rate = A/E (70%)
A
E
6520 85Age
Slightly more complex case
Increasing income with age
earnings
annuity
consumption
replacement rate = A/E (60%)
A
E
Better comparison
Average lifetime earnings rather than final earnings
Already more difficult...data requirements, interest rate assumptions etc
But what about changes in household composition?
Ann born
Aunt Tilly visits
replacement rate = A/E (35%)
This household will want to allocate fewer resources to retirement
phase
• Will want lower replacement rate whether measured with respect to final income or life-time income
• Thus in relatively simple situation, no universal replacement rate
Another situation
• No pensions
• Only savings
• Income in retirement is small...interest on wealth
• Clear: income replacement rate makes no sense
Actual situation
• Mix between pension and savings– Varies across people and across countries
• Solution in literature: annuitize savings– But people don’t annuitize– Not an accurate description of saving
adequacy
Other issues
• the differing role of taxes for households at different points in the income distribution;
• work-related expenses;
• the time horizon or survival curve of the household;
• returns to scale in consumption: reduced spending once one of the partners dies;
• the changing consumption profile with age;
• Differential mortality
Survival curves for men
0
20
40
60
80
100
120
62 72 82 92 102
sngl. E=1
sngl. E=2
sngl. E=3
sngl. E=4
mrd. E=1
mrd. E=2
mrd. E=3
mrd. E=4Single. Less than high school education
Married. College graduate
Those with fewer resources need fewer resources
One additional problem
• Different uncertainties after retirement
• Insurance incomplete and varies from person to person and across countries
All these problems remain when savings annuitized and added to pensions
And no solution to this problem
Ann born
Aunt Tilly visits
replacement rate = A/E (35%)
Inevitably drawn to an economic model to make comparisons
• But what model?
• Life-cycle model says what an informed utility maximizer would do.
• Obvious starting point
• Does not lead to income replacement rate concept
What do we see in U.S. when use life-cycle model?
• Compare actual wealth with optimal wealth– Over-saving! (Schulz et al, 2006)
– But lifetime utility below optimum
• Compare consumption at retirement (and associated with life-cycle path) with economic resources
Almost 80% adequately prepared (Hurd and Rohwedder, 2008)
How did households achieve this?
• We don’t know
• All we can do is to assess outcome
Relevance for Europe
• With reduction in state DB pensions larger mix of savings and private pensions
• U.S. experience may be relevant for future
This paper
• Conceptualize situation
• Input into debate
• But to implement measures of economic preparation need data– Is there something between income
replacement and full-scale life-cycle model?
• Excellent start