Pension Expert Discusses the New Retirement

Bankrate.com

As one of America's leading researchers on finance, employee benefit plans and retirement economics, Olivia S. Mitchell was tapped by the National Institute on Aging, or NIA, to collaborate on one of the most comprehensive studies on aging ever undertaken.

Long-ranging and extensive in scope, the study has surveyed more than 27,000 people age 50 and older since 1992 and has yielded a mother lode of information on the consequences of retirement and the relationship between health, income and wealth over time.

The result, The Health & Retirement Study, or HRS, is a cooperative effort managed by the NIA and the University of Michigan's Institute for Social Research.

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Bankrate.com caught up with Mitchell as she was returning from an international conference for pension fund managers in Lima, Peru.

Changing face of aging

Q: The HRS study data indicates a larger proportion of baby boomers expect to be working after age 65. What factors are contributing to that expectation?

A: Boomers are beginning to understand that they are more likely to live for a long time in retirement, thus requiring more financing for retirement than in the past. Also, Social Security and Medicare are in a precarious state. So working longer offers a chance to save up more and sustain an income at an older age. And since there are fewer young people in the labor force, employers are actively seeking to keep older workers in many cases, so they won't lose the know-how and productivity.

Q: Data from the study indicates that we incur higher out-of-pocket medical expenditures as we grow older -- mostly for prescription drugs. How much should Americans put aside, in addition to regular retirement savings, to account for unexpected health events and cover the cost of medicines?

At a glance

Name: Olivia S. Mitchell, Ph.D.
Hometown: Bala Cynwyd, Pa.
Education: Master's (1976) and doctorate (1978) degrees in economics from the University of Wisconsin-Madison. Bachelor's degree (1974) in economics from Harvard University.

Career highlights:

• Professor at the Wharton School of the University of Pennsylvania; executive director of the school's Pension Research Council; director of the school's Boettner Center for Pensions and Retirement Research.

• Co-investigator for the Health and Retirement Study at the University of Michigan.

• Serves on the board of the University of Pennsylvania Population Aging Research Center.

• Research associate at the National Bureau of Economic Research.

• Served on President Bush's Commission to Strengthen Social Security.

• Served on the U.S. Department of Labor's Employment Retirement Income Security Act, or ERISA, Advisory Council.

• Co-author of numerous publications on retirement, pensions, public finance and risk management.

A: Nobody knows for sure, since future medical care costs are some of the most difficult to predict -- along with possible medical breakthroughs. Knowledgeable groups have estimated $250,000 is likely to cover the expected present value of out-of-pocket costs for a 65-year-old retiree (including premiums).The number is higher for an early retiree not yet eligible for Medicare. But this assumes that Medicare benefits can continue to be paid as now, and this is a big "if" since the system is facing shortfalls.

Q: The study queried people in their mid-50s to find out if they expect to be working after age 65. The highest percentage of those answering yes came from respondents with some college education or college degrees. Next were those with some high school or with high school degrees. What factors drove this outcome? Is it the nature of work/benefits offered to the specific demographic or does it have to do with varying levels of financial knowledge?

A: People who are more educated are more likely to have jobs where they can keep working into their later years, which is one explanation for deferred retirement. Also, people who are more educated tend to be higher paid, so Social Security doesn't provide as large a benefit for them, relatively speaking, as it does for lower earners. For this reason, working longer can contribute to higher saving and an eventually better-funded retirement for the more highly educated. Finally, the better-educated were also the most likely to understand the need to plan for retirement and to carry out a plan. So working longer is likely to be consistent with this plan.

Q: According to your study, the recent reversal of the trend toward early retirement may be due to changes in retirement incentives in the Social Security program and the elimination of mandatory retirement. Another factor may be the rising popularity of defined-contribution plans, such as 401(k) plans, as opposed to defined-benefit plans (traditional pension plans). Could you briefly describe how these changes/trends affect today's overall retirement landscape?

A: In the past, defined-benefit plans tended to encourage working up to a given age -- usually somewhere in the early 60s. Then pension values were generally cut for anyone who remained on the job after that point. Faced with these disincentives, most workers left their jobs early. In the past, mandatory retirement rules also strongly discouraged continued work. Now, mandatory retirement is outlawed for most jobs, and defined-benefit plans have, in many cases, been replaced by 401(k) plans along with other defined-contribution pensions. In defined-contribution plans, longer work years mean more contributions, which grow one's pension more. As a result, the implied and explicit incentives to leave early have been eroded.

Q: Individuals with access to defined-contribution plans assume all the risk, and businesses that offer defined-benefit plans assume all the risk. The Pension Protection Act passed a couple of years ago requires businesses to shore up their pension plans. Has this led to more frozen plans or conversions to cash-balance plans?

A: It's incorrect to assume that businesses offering defined-benefit plans assume all the risk, since surely the pilots and flight attendants of bankrupt airlines experienced a great deal of risk when their firms failed and their benefits were cut dramatically. Defined-benefit plans also rewarded only a few with a final pension -- the few who made it all the way to retirement age. A large number of employees who started with these employers never got a defined-benefit plan. Conversely, defined-contribution plans are safer for those with high turnover rates and in companies that face bankruptcy risk -- as long as there is not too much employer stock is in these plans.

The Pension Protection Act embodied provisions that strengthened funding for defined-benefit plans and also made defined-contribution plans more attractive. But I don't see it as having tilted the playing field either way.

Q: What are the pros and cons of defined-contribution plans, such as 401(k) plans, from the viewpoint of the average American?

A: Defined-contribution plans work well for mobile employees who are sensible enough to put away their money and fortunate to get an employer match. Defined-contribution plans are now moving to "auto-enrollment," which is sensible for workers who might not appreciate the benefits of retirement saving. They are also offering life-cycle funds (also called age-based funds or retirement-date target funds), which are great for people who are not confident enough to select funds on their own. Defined-contribution plans are portable and allow one to move the money after leaving the job and defined-contribution plans don't encourage early retirement, which I see as a positive.

Q: The HRS study suggests household spending across the board is reduced once people go into active retirement. Do you think this behavior is because people don't realistically anticipate their retirement consumption needs, and subsequently, are being forced to lower their standard of living?

A: The HRS shows that people anticipate they will spend less in retirement prior to making this transition, and then they follow through. So it is not much of a surprise for most people. The main explanation seems to be that people spend less eating out, buying work clothes and paying for transportation after they retire, so that the reduction in spending is probably sensible. And they also devote more time to comparison-shopping and "home production," meaning making their own food rather than eating in restaurants.
Q: How do changes in marital status influence a retiree's wealth? And are there differences based on gender?

A: Divorce and death usually reduce women's wealth substantially. The evidence is less conclusive for men.

Q: When it comes to overall wealth, how important is it for Americans entering into or saving for retirement to have a varied portfolio of investments and savings? Especially when most people consider the value of their home the most important component of wealth, and home values are declining in most markets?

A: Diversification is essential for having a well-rounded investment strategy. In particular, it is important not to have all one's eggs in one's housing basket, particularly given the downward trend in housing prices of late.

Q: The study suggests that the annual cost of informal caregiving associated with certain illnesses can be billions of dollars annually. Further, the financial costs incurred by families who provide informal care (through reduced hours of paid work) can be significant. If long-term care insurance is a viable option to help defray such costs, why are relatively few older adults purchasing it?

A: Research shows that many people wrongly believe that Medicare is going to pay for their nursing homes. The fact is, Medicare won't cover most long-term care expenses. However, Medicaid may, and this strongly deters people from purchasing long-term care insurance.

(Reporter's note: Medicare Part A will cover the full cost of up to 20 days in a skilled nursing facility. For days 21 to 100, the patient pays up to $128 per day. After 100 days, the patient pays for the full cost of the stay until the benefit period renews. The patient must meet certain eligibility requirements. Source: www.medicare.gov.)

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