BACK TO WEB VERSION

FALL 2007
To Look Before They Leap
by Kathleen Cason

In simpler times, a good retirement plan was to have children. Parents would care for children when they were young; and the children, later in life, would care for their parents. But since World War II, retirement planning has become more complex.

“If you are going to retire, you’ll have to draw money from somewhere,” said Jason Seligman, a research economist at UGA’s Carl Vinson Institute of Government. For most Americans, that “somewhere” is often described as a three-legged stool—private savings, Social Security benefits and employer contribution plans. Some suggest that the stool now has a fourth leg—returning to work, at least part-time.

With some 82 million baby boomers on the cusp of retiring, individual retirement security has implications for the whole national economy. But three legs or four, the stool at present is a bit shaky. Personal savings are low and fiscal uncertainties surround Social Security. Increasingly, an individual’s retirement security hinges on managing resources within employer-sponsored retirement plans.

Women More at Risk

Despite its importance to a great many people, some academics might consider pensions insufficiently scholarly, even boring. Not this scholar. Jason Seligman came to UGA in 2002 after serving in the U.S. Treasury Department and on the White House Council of Economic Advisors, under both the Clinton and Bush administrations.

By using simulations and mathematical analyses, Seligman and his colleagues are examining factors—such as unemployment, changes in employer health-insurance plans, employer-based financial education, and workforce absences for child-rearing—that affect retirement security. Their findings can help inform policymakers and financial institutions that design and regulate retirement plans, whether public or private.

For example, Seligman and Yoko Mimura, a UGA researcher in housing and consumer economics, have studied the impact of workforce absences on a woman’s retirement security. “The trend is to make people responsible for their own retirement,” Mimura said. “But women with children at home save less for future retirement.”

This phenomenon may be caused by exits from the labor force, working fewer hours or taking a lower-stress job to meet family needs. In any case, labor-force exits can be costly, Seligman said. A woman who has left the workforce to care for children or older relatives will have worked fewer years, and probably for lower wages, than the average man, so she will have contributed less to a pension plan.

“She is more likely to outlive her spouse,” said Seligman, “but on her own she has accumulated fewer resources for what will in all likelihood be a longer retirement.” His and Mimura’s studies provide basic information for helping women avoid such dilemmas. Their analyses “determine the cost of women’s earning gaps,” he said, “and the impacts of a lower base wage on retirement security.”

Allowing for “Down Time”

In another study, Seligman and Jeff Wenger, a public-policy analyst at UGA’s School of Public and International Affairs, examined the relationship between retirement savings and unemployment.

“We ran a simulation of the U.S. economy a number of times to find out whether unemployment caused people, both at the bottom and top earnings distributions, to lose favorable investment opportunities,” Wenger said.

The financial market leads the labor market, so layoffs tend to occur when stocks are at their peak. As stock values fall, individuals would like to “buy in the dip,” but they don’t have the income to do that. “This is not a recipe for successful investing,” said Wenger. “Low wage workers may be laid off two or thee times during their working lives, and that adds up—especially when the layoffs occur early in a career.” He and Seligman found that some workers could lose up to 15 percent of their pension portfolios.

An important lesson from this study is that workers need to account for possible job losses,” according to Wenger. “Instead of making retirement-savings plans for 40 consecutive years, you need to plan for being out of the market—and being out of it at a bad time.”

A Shifting of the Risks

Until the 1980s, most employers offered workers “defined benefit” plans that provided guaranteed retirement income, with the amount based on a formula that considered salary and years of service. “For the majority, over time, the defined-benefit system has seemed very safe because that money is presumably there every month after you retire,” said Seligman. “But if your company goes bankrupt or you quit your job before you vest, you get nothing.”

Over the past 30 years, defined-benefit plans have increasingly been replaced by “defined contribution” programs, which work quite differently. “In defined-contribution programs, the money you save is yours,” Seligman said. “If the company you work for goes bankrupt, the account is still yours. Any time you leave an employer, the savings are handed to you in one chunk, or at least you have the option to take it in one chunk.”

Moreover, defined-contribution plans—such as 401(K)s, 403(b)s and Individual Retirement Accounts—allow participants some control over how much they save. “Generally, if you put the money into the equity market, you are likely to get healthy returns,” Seligman said. “If you make different investment decisions, things go better or worse.”

Because a defined-contribution plan shifts the risk burden from the employer to the individual, this strategy has been considered in recent years for public pension programs. In fact, Seligman and David Richardson, an economist at Georgia State University on leave at the President’s Council of Economic Advisors, published a study that reviewed the risks of changing Social Security from a defined-benefit to a defined-contribution plan. They found that such a transition would indeed shift the retirement security risk from the government to individuals. But as a result of reduced availability of funds, it would also place stress on federal programs such as Medicare and disability insurance.

Managing the Chunk of Money Wisely

Seligman’s latest research effort—the Retirement Transition Project—looks at how retirees manage those “chunks,” or lump-sum distributions, when they choose to receive them from former employers. “Lump-sum distributions have tax consequences as well as consumption consequences,” Seligman said. “There are all sorts of risks that could mean your plan fails to provide for you.”

A major risk is “the miracle of compound interest in reverse,” said Seligman. “As you begin to consume your nest egg, the principal earns less interest, and each year it is easier to consume a greater proportion of the remaining assets. Given current savings behaviors and longevity patterns, that creates a big concern—one the Retirement Transition Project is attempting to address.”

More than 300 Georgians—self-identified as retiring within a year and facing lump-sum distribution decisions—are participating in the study, which is supported in part by a grant from the National Endowment for Financial Education. So far, participants have undergone an in-depth interview to determine the individual’s baseline status.

By comparing the baseline survey with other national surveys from the University of Michigan and Dartmouth College, Seligman said, he hopes to learn a great deal about retirement-decision behaviors and resulting financial and even psychological health. “We are testing whether or not there are ways to improve financial acumen, savings performance and comfort levels for people making these decisions,” he said. During the next two years, Seligman will track how this group makes the financial transition from worker to retiree.

“We’re going to learn about the value of surveying people as well,” he said. “It may turn out that asking them difficult questions is the best way to engage their decision-making faculties. It can be discomforting to learn that you do not have a clear idea of how you will finance retirement, but it is better to realize this before you retire.”

(Kathleen Cason is public relations coordinator in UGA’s Office of the Vice President for Service and Outreach).