1. Is There Evidence Workers Are Rational in Preparing for Retirement? by Gary Burtless Senior Fellow and Whitehead Chair in Economics The Brookings Institution Washington, DC May 2009 Seoul, Korea

2. Changes in retirement system  Future drop in Social Security benefits  Evolution of workplace-based pensions  OUT: Traditional DB plans  IN: Worker-directed DC plans  Critical decisions on saving rate and investment allocation  OLD: Made by employers  NEW: Made by workers

3. Disappearance of traditional DB pensions in the private sector (1979-2005) Workers covered solely by a DB plan Covered by both kinds of plan 63% 16% 62% 10%

4. Rationality of workers’ retirement planning choices  Do they save enough to afford the retirement ages they choose?  Do they have enough to live on after they retire?  Do they prudently allocate savings across different asset classes?

5. Rationality of workers’ retirement choices  Is there evidence the retirement age is result of deliberate and rational plan involving lifetime optimization?  Second – Do workers save enough to retire comfortably? Or is there substantial under-saving?  Third – How well do workers allocate their retirement savings?

6. Earnings & consumption over the life cycle … theory

7. Wealth build-up over the life- cycle … theory

8. Evidence that the age of retirement is result of deliberate and rational plan involving lifetime optimization? … Yes  In the aggregate – Retirement rates at successive ages reflect retirement incentives in the most important U.S. pension program.  People retire at ages 62 and 65  Age 62 became more vastly more important after 1961.  Within single companies – Sophisticated decision rules more successful than naïve rules in predicting retirement ages.  Internationally – Aggregate and time-series evidence from other industrialized countries conforms with U.S. patterns.

9. Percentage of men actually retiring at successive ages – 1969-1979 (LRHS)

10. Evidence that the age of retirement is result of deliberate and rational plan involving lifetime optimization? … No  Aggregate evidence consistent with naïve decision rules – Gradual reduction in retirement age may reflect imitation or simple availability of pension income.  Many (most?) workers ignorant of pension rules – If they don’t know the rules, how can their decisions be well- informed or rational?  The most common survey responses – “I have no retirement plans” and “I have not thought about retirement”

11. Do workers save enough to retire comfortably? … No Or is there substantial under-saving? … Yes  Workers say they’ve saved too little.  Many workers have almost no savings as they near traditional retirement age.  A large minority of workers experiences a drop in consumption after retirement – Inconsistent with traditional “rational” retirement models.  Most workers would need big increase in saving to maintain pre- retirement consumption after they retire – Baby boomers may under-save by one-third or more of what is needed for level consumption.  Drop in U.S. saving rate … when it should have risen.

12. U.S. total private and personal saving, 1952-2006

13. Do workers save enough to retire comfortably? … Yes Or is there substantial under-saving? … No  Workers with no savings can fall back on state pension or public assistance … or possibly on relatives.  Most under-savers would not need much extra saving to maintain pre- retirement consumption after they retire – The under-saving may big % of current saving, but is typically a small % of lifetime earnings.  The declines in consumption after retirement are usually anticipated – It costs less to be retired than to work.  The declines in consumption may be rational – Workers would need very high saving rates to protect themselves completely against every contingency. Also, they might die a couple of years after they retire.  Elderly are no more likely to be poor than are non-elderly.

14. U.S. poverty rate among aged and non- aged adults, 1959-2006

15. Do workers allocate their retirement savings in a rational (or at least plausible) way?  U.S. workers on average invest more than half in risky asset class: Equities.  However, many invest nothing in risky assets.  There is very little portfolio re-balancing. 10-year period  In 10-year period, only 27% made any change in their existing portfolios  Only 53% made reallocation of new contributions  Financial illiteracy of worker-investors:  Three-quarters are unaware you can lose money in bond mutual fund  Even more are unaware that a fund’s cost subtracts from net fund returns  Framing effects in fund selection: Choosing among A, B, C, & D —  Investors prefer B over C if C is the extreme choice, but C over B if C is the extreme choice.

16. My conclusion  If economists squint hard, they see evidence of “rationality” in  Timing of retirement  Saving for retirement  Post-retirement consumption  Investment allocation of retirement savings  But if we ask 1,000 randomly selected workers what they know about their pensions and investments and how much they’ve planned for retirement, it’s hard to be confident far- sighted rationality is the norm.