Adequacy%20of%20Saving%20for%20Old-Age%20in%20Europe

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Adequacy of Saving for Old-Age in Europe

• Discussion by Michael Hurd

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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.

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Popular press and some research

• Baby-boomers headed for poverty in retirement!
• 60 not adequately prepared!
• Need 2M in retirement assets!
• Etc.

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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?

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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

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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

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replacement rate A/E (70)
earnings
annuity
E
consumption
A
65
20
85
Age
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Slightly more complex case

• Increasing income with age

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replacement rate A/E (60)
earnings
annuity
E
consumption
A
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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?

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replacement rate A/E (35)
Aunt Tilly visits
Ann born
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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

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Another situation

• No pensions
• Only savings
• Income in retirement is small...interest on
  wealth
• Clear income replacement rate makes no sense

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Actual situation

• Mix between pension and savings
• Varies across people and across countries
• Solution in literature annuitize savings
• But people dont annuitize
• Not an accurate description of saving adequacy

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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

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Married. College graduate
Single. Less than high school education
Those with fewer resources need fewer resources
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One additional problem

• Different uncertainties after retirement
• Insurance incomplete and varies from person to
  person and across countries

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All these problems remain when savings annuitized
and added to pensions

• And no solution to this problem

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replacement rate A/E (35)
Aunt Tilly visits
Ann born
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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

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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)

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How did households achieve this?

• We dont know
• All we can do is to assess outcome

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Relevance for Europe

• With reduction in state DB pensions larger mix of
  savings and private pensions
• U.S. experience may be relevant for future

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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