Lifetime Earnings, Social Security Benefits, and the Adequacy of Retirement Wealth Accumulation

By Engen, Eric M.; Gale, William G. et al. | Social Security Bulletin, January 1, 2005 | Go to article overview
Save to active project

Lifetime Earnings, Social Security Benefits, and the Adequacy of Retirement Wealth Accumulation

Engen, Eric M., Gale, William G., Uccello, Cori E., Social Security Bulletin

Summary and Introduction

The United States has traditionally depended on the so-called three-legged stool-Social security, private pensions, and additional personal saving-to finance retirement, but all three legs are becoming increasingly creaky. Social security and Medicare face long-term financial shortfalls, because of a combination of the imminent retirement of the baby-boom generation, generally lengthening life spans, and rising health care costs and per capita health care expenditures, which are projected to continue increasing in the coming decades. The trend in pensions from defined benefit to defined contribution plans brings with it a set of opportunities but also a set of risks for future retirees. Aggregate saving rates have been extremely low in recent years, and evidence shows that some households save very little, especially in the form of financial assets.

The extent to which households are already saving adequately for retirement is thus an important issue for policymakers, especially as they deal with issues like Social security reform. It is also a central issue in academic research that aims to understand the forces that shape the way people make forward-looking decisions on saving.

Despite the importance of the question, there is significant controversy about how well households are preparing for retirement. Researchers have taken a wide variety of approaches to examine the issue, including measuring changes in household consumption at the time of retirement, calculating the annuitized value of existing wealth, comparing the wealth accumulation patterns of current and previous generations, and comparing the results of simulation models of optimal wealth accumulation with households' actual saving behavior. Each approach generates useful information, but each also has shortcomings that may limit the applicability of the results.1

This article provides new evidence on the adequacy of household wealth accumulation. The research departs from most of the previous analyses in two key ways. First, whereas most simulation models of optimal wealth accumulation assume that earnings are nonstochastic, this research follows earlier work (Engen, Gale, andUccello 1999) in deriving optimal wealth accumulation patterns for households in a stochastic life-cycle model that allows for uncertainty in earnings and mortality. Uncertainty about future earnings implies that there will be a distribution of optimal wealth-to-earnings ratios, rather than a single benchmark ratio, among households that are otherwise observationally equivalent (that is, households that are similar on the basis of age, education, pension status, marital status, and wage history). This finding fundamentally changes the interpretation of observed saving patterns relative to a nonstochastic model. In particular, it implies that some households should be expected to exhibit low ratios of wealth to lifetime earnings, even if every household is forwardlooking and makes optimal choices. The notion that low levels of saving could still represent adequate replacement rates is reinforced by the notion that the federal government provides Social Security payments and Medicare benefits to retirees.

The second way in which this analysis departs from most of the previous research is to base the measures of adequate wealth accumulation on lifetime earnings rather on than current earnings.2 There are several reasons to believe that using data on lifetime earnings will prove useful in studying the adequacy of saving. Most importantly, lifetime earnings are almost certainly more closely correlated with economic well-being during working years and desired economic status in retirement than are earnings in any particular year. In addition, use of lifetime earnings may help clarify who is saving too little. For example, Mitchell, Moore, and Phillips (1998) andEngen, Gale, and Uccello (1999) found that, controlling for other factors, it was less likely that households with higher current earnings were saving adequately for retirement, when adequate saving was defined as having a sufficiently high ratio of wealth to current earnings.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Cite this article

Cited article

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

Lifetime Earnings, Social Security Benefits, and the Adequacy of Retirement Wealth Accumulation


Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?