Assessing Knowledge of Retirement Behavior (1996) / Chapter Skim
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3 FACTORS AFFECTING LABOR SUPPLY DECISIONS AND RETIREMENT INCOME
3 FACTORS AFFECTING LABOR SUPPLY DECISIONS AND RETIREMENT INCOME
Pages 61-122
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From page 61... ...
cites the "life-cycle view of work, saving, and consumption" as the motivating influence behind the behavioral focus of the retirement literature, particularly with regard to decisions about Social Security, pensions, leaving a career job, and accepting post-retirement work. Recognizing the life-cycle view, economists have concentrated not just on the final decision to retire but on the individual's whole history of labor force participation decisions.
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From page 62... ...
The next five sections focus on specific key areas that potentially affect the labor supply decision, the transition to retirement, and associated retirement income: Social Security, pensions and early retirement "window" plans, disability, Medicare and other forms of health insurance, and job characteristics. Each of these sections begins with a summary of questions and currently available techniques for addressing them.
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From page 63... ...
FACTORS AFFECTING LABOR SUPPLY DECISIONS AND RETIREME~ INCOME 63 50 40 30 C' ILL 20 10 o Income below poverty threshold Income below 125% of poverty threshold Income below 150% of poverty threshold \ \ \ %%, \ \ \ / / / / \ N \ _ \ \ ~ Hi`/ , ~_ _ _ ,,% ~ / / , ~, < 5 1 20-24 40-44 1 60-64 1 80-84 1 0-14 30-34 50-54 70-74 Age of person FIGURE 3-1 Percentage of persons below poverty and near poverty thresholds, by age, 1990.
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From page 64... ...
document various components of elderly wealth and labor force participation and discuss their interaction. Auerbach, Kotlikoff, and Well (1992)
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From page 65... ...
In 1990, average replacement rates for Social Security varied from 28 percent for maximum earners to 56 percent for low wage earners. Currently only 12 percent of employers surveyed have pension plans that are designed around specific replacement rate goals.
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While an obvious solution to the threat of inadequate retirement income is a shortened retirement phase (through either prolonged work, delayed retirement, or earlier mortality) , trends both in labor force participation and life expectancies suggest that retirement savings will need to be stretched over more years of life
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From page 67... ...
As a result, the gap between male and female labor force participation has narrowed over the last two decades, by about 15 percentage points for those aged 50 to 62 (Peracchi and Welch, 1994~. In addition, the modal labor TABLE 3-1 Percentage of Women Over Age 62 Receiving Social Security on the Basis of Their Own Work History Year 1960 1970 1980 1988 Percent 50.6 56.9 59.7 SOURCE: U.S.
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From page 68... ...
In addition to declining labor force participation trends, life expectancies are also increasing. Table 3-3 shows life expectancies and projections for white men and women under three different demographic scenarios (these are described in Hurd, 1994b)
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From page 69... ...
. Because of these trends, the ratio of the retired population to the working population is expected to rise from 0.21 in 1990 to 0.27 in 2020 to 0.37 in 2035 (Congressional Budget Office, 1993~.
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From page 70... ...
Because Social Security affects so much of the elderly population, it is the obvious place to start in discussing broad-based policy changes that influence retirement behavior and income. Previous research considering the effects of changes in Social Security policy on retirement and labor force participation includes Gustman and Steinmeier (1991)
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In order to increase labor force participation and decrease the burden on the Social Security system, current Social Security policy dictates an increase in the normal retirement age from 65 to 67. Those born in 1937 will be the last group with a normal retirement age of 65.
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, who demonstrate via simulation, using data from two individual Fortune 500 firms, that for individuals with pension plan availability, changes in Social Security policy will have very little effect. They attribute this to the relative magnitudes of pension versus Social Security benefits.
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to assess the impact of changing the delayed retirement credit from 3 percent to 8 percent and of eliminating the earnings test. The SCF has the advantage of also containing information about pension plans.
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were made prior to the normal retirement age (Kingson,1992~; it is therefore unlikely that changes to this later age would have substantial effects on retirement behavior. Leonesio (1993b)
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cite difficulties in inference on labor supply behavior with nationally representative data owing to a lack of detailed pension plan information. This is particularly important when analyzing the behavior of men, for whom pension benefits are a greater proportion of retirement income.
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argue that in response to increased pension regulation and to legislation, the 1980s have seen a shift from defined benefit to defined contribution pension plans.
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, have a profound effect on the labor force participation rates of the target group. Literature Review and Previous Methodology Much of the literature on pension plans and retirement is based on results using static models.
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Using separation as the dependent variable in a reduced-form probit model, they find that pension plans are not a substitute for wage compensation; instead compensation in pension-covered jobs is higher. The "compensation premium" rather than the nonportability of pension plans accounts for increased attachment to the firm.
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Simulations implementing the shift of the Social Security normal retirement age to 67 produce a corresponding shift in the latter peak in retirement rates. Stock and Wise (199Oa, l990b)
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simulate the effects of a number of different policy changes, using data from another Fortune 500 firm. Besides confirming their earlier results using this alternative data set, they investigate the effects on labor force participation of changes in the Social Security early and normal retirement ages, the private pension plan provisions,
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From page 81... ...
For those people who will receive pension benefits, the magnitude of the expected benefit is such that pension plan provisions can strongly influence their retirement decision. What We Would Like to Know An important aspect of modeling the determinants of retirement behavior and retirement income is understanding how Social Security and pensions interact with other forms of retirement savings.
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From page 82... ...
Gender differences in pension coverage become even more pronounced when measuring receipt; women are much more likely to experience interruptions in labor force attachment and are thus less likely to meet vesting requirements in a pension plan than men.5 In 1992, median income from private pensions for male recipients was approximately twice that of female recipients, at all 5-year age intervals for individuals above age 65 (Grad, 1994~. When tenure is controlled for, coverage rates are fairly similar, as shown in Table 3-5.
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From page 83... ...
Quinn, Burkhauser, and Myers (1990) suggest that if increasing pension coverage is responsible for the observed trend towards early retirement, a leveling off of coverage may signal a corresponding increase in average retirement ages relative to current projections.
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for evidence that this promotes early retirement. Much of the literature has used large aggregate data sets to investigate the influence of pension plans on the retirement decision.
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that pension plans, particularly defined benefit plans, have incentive effects that firms can use to manipulate the composition of their employees. Federal regulations have sought to limit these incentive effects (Clark, Gohmann, and McDermed, 1988~.
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With focus shifting to issues of solvency of government programs, private sources of retirement income, such as pension plans, as well as individual savings, will become increasingly important. As discussed earlier, Auerbach, Kotlikoff, and Well (1992)
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, who argue instead that the cause is the omission of other key considerations, most noticeably, Medicare. DISABILITY There is increasing discussion about the relation between Social Security disability insurance and retirement and about the possibility that liberalization of disability benefits is partially responsible for declines in labor force participation (see discussion in Rust, 1989; Lewin-VHI, 1994~.
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In addition, disability benefits, like Social Security benefits, are subject to an earnings test at $500 per month. Both of these features inhibit subsequent labor force participation.
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. graphic trends (e.g., the increase in female labor force participation, the aging of the baby boom cohort)
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Nevertheless, it is apparent that individuals should not rely on disability payments as their primary source of retirement income before age 65. While the Social Security trust fund is projected to have a surplus through 2015 and become exhausted in 2044, the disability insurance trust fund is expected to become insolvent in 1995 (Congressional Budget Office, 1993~.
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NOTE: Award rates for men (women) are calculated as the number of awards to men (women)
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There have also been a number of models that have attempted to capture the dynamic nature of the disability-application decision using pooled individuallevel data. Such data have often been used to characterize other decision processes such as the labor force participation decision and the Social Security application decision.
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should be employed in related contexts, such as in comparing the relationship between labor force participation and the application for disability insurance. Bound (1989)
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Parsons argues that even after application denial, the disability system plays a significant role in individuals' future labor force participation decisions.
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_ en to 3.0 . _ en o of 5.0 1.0 o ~ / Nonparticipation rate / \~ __1__1~' / _/ / IN '' Social Security disability recipiency rate 1950 1960 1970 1980 Year FIGURE 3-10 Nonparticipation in the labor force and Social Security disability recipiency, males aged 45-54, 1947-1982.
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From page 96... ...
Parsons investigates self-screening efficiency, that is, the accuracy of this selection mechanism. MEDICARE AND HEALTH INSURANCE Much of the concern about the adequacy of retirement income is due to the uncertainty surrounding future events and needs, particularly health status and health care costs.
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As a result, retiree health insurance is increasing in importance. Like other fringe benefits such as pensions, retiree health insurance may have powerful incentive effects.
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From page 98... ...
In considering the interaction between employer-provided health insurance and retirement behavior, they predict a minor effect on labor supply; the magnitude of the effect is considerably less than a year. Gustman and Steinmeier simulate the effects of a variety of retiree health insurance assumptions.
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From page 99... ...
study on the impact of policy changes to Social Security, Gustman and Steinmeier measure the effect of providing retiree health insurance to be a change (in this case a decrease) in the average date of retirement of roughly the same magnitude; individuals would retire approximately 3 weeks earlier.
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From page 100... ...
Opponents cite unsurmountable costs while proponents argue that lack of universal coverage reduces labor mobility and stifles entrepreneurship (by discouraging self-employment) because employer-provided health insurance, like defined benefit pensions, are typically not portable and often contain pre-existing condition clauses.
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From page 101... ...
To the extent that Medicare influences the retirement decision, increasing the Medicare eligibility age may be another way policy makers can increase labor force participation. If, instead, Medicare application occurs because other sources of health insurance are limited at age 65, increasing the eligibility age may have the undesirable effect of raising the proportion of uninsured individuals.
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From page 102... ...
The HRS combines detailed questions on health with specific pension plan information and will allow researchers to model a richer set of dynamics than was previously possible. HOURS FLEXIBILITY AND CAREER JOBS In their models of retirement behavior, Gordon and Blinder (1980)
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From page 103... ...
Looking at working age women, she finds that 40.5 percent of women in her sample had been in all three states of labor force participation (full time, part time, out of the labor force) during a 14-year period, as opposed to just 6.3 percent of men.
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From page 104... ...
The observation that partial retirement occurs mainly between ages 62 and 67 indicates the influence of the Social Security earnings test. Nearly 25 percent of retirees reenter the labor force, with almost one-third choosing full labor force participation.
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From page 105... ...
In addition, more than twice as many reentrants move back to full-time versus part-time jobs and wage and salaried jobs verus self-employment. Unfortunately, neither of these data sets contains substantial detail on pension coverage or receipt, so it is impossible to determine the extent to which reentry is a means of supplementing a pension benefit or obtaining health insurance.
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From page 106... ...
Blank (1994) compares three dynamic discrete choice models of labor force behavior: a 3-lag model that allows for complex dependence of the current decision on a short history of past labor force participation decisions, a 13-lag model that has a simplified dependence structure but allows influence of a longer history, and a random effects logit model that ignores previous history but allows for unmeasured heterogeneity.
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From page 107... ...
It would be interesting to simulate a retirement from a career job followed by a series of shorter jobs, all with pension plans. In particular, it is possible, because of shorter vesting periods and the incentive effects in defined benefit plans to retire early, that such a strategy may increase retirement income.
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From page 108... ...
They recommend improvements in modeling work lives and incorporating entire work histories. One possible reason they offer for increased mortality risk associated with multiple transitions between unrelated jobs is due to inadequate pension and health insurance benefits, which may cause increased stress surrounding retirement.
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Identifying misperceptions will improve the way in which an econometrician can model the decision process, particularly when many existing models do not incorporate such uncertainties. CONCLUSIONS What determines retirement and retirement income?
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, of 25 million workers who were in defined benefit pension plans, 18 million (72%) were incorrect about, or did not know, when they could retire with full benefits (16% said they did not know)
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Because they at most incorporate all current and past information, they obviously are unable to capture significant legislative or health changes in the future. Adequately modeling expectations and uncertainty surrounding future changes, which perhaps represent the biggest threat to retirement income security, is crucial to understanding the factors influencing labor force participation decisions and represents a substantial challenge for research.
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From page 112... ...
The problem is the computational burden involved. This is a problem with dynamic programming models in general, where, without simplifying assumptions, the number of nodes in the decision tree increases exponentially with the number of time periods (i.e., nodes = CT, where C is the number of choices and T is the number of time periods)
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From page 113... ...
It is also important in dynamic models to control for aggregate uncertainty; in the case of pension plans this could include the financial condition of the firm or the termination of the plan. At more macroeconomic levels, this includes concerns over solvency of public programs such as Social Security, disability insurance, and Medicare.
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From page 114... ...
those who were high wage earners in their work lives and who therefore have adequate retirement income (in the form of pension benefits, a post-retirement job, low medical expenditures, and high levels of savings) and those who were not (having less attachment to the labor force, lower probability of a pension, and being in poorer health)
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From page 115... ...
Keane and Wolpin provide a four-dimensional example, where an individual's labor force participation decision is between two occupations, schooling, and staying home. REFERENCES Allen, S.G., R.L.
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Gohmann, and A.A. McDermed 1988 Declining Use of Defined Benefit Pension Plans: Is Federal Regulation the Reason?
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:733-745. 1993a Employer Provided Health Insurance and Retirement Behavior.
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Penrod, and H.S. Rosen 1994 Health Insurance and the Supply of Entrepreneurs.
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Chicago, Ill.: University of Chicago Press. 1987 The incentive effects of private pension plans.
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:117134. 1984 Disability insurance and male labor force participation: A response to Haveman and Wolfe.
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1988 Measuring the effect of disability on labor force participation. Journal of Human Resources 24(3)
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1994 The work and retirement decisions of older women: A literature review. Social Security Bulletin 57(1)
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