The Interplay of Wealth, Retirement Decisions, Policy and Economic Shocks
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Abstract
We develop a model of health investments and consumption over the life cycle where health affects longevity, provides flow utility, and retirement is endogenous. We develop a rich, numerical life-cycle model to study the complex interrelationship between health and wealth and the age of retirement. The decision to retire depends on a number of factors including earnings and health shocks, demographic characteristics, preferences, pensions, and social security. We incorporate these features in a computational model of optimal wealth and retirement decisions, solving the model household-by-household using data from the HRS. We use the model to study how workers would respond to an increase in the early eligibility age of retirement (EEA), and to what extent will the bad economy alter retirement plans. We find that increasing the EEA results in sizeable responses to the age of retirement but does not affect health outcomes very much. A 20 percent reduction in wealth induces households to delay retirement by one year, on average, with poor households being relatively unaffected.
Key Findings
- Using a life-cycle model we analyze, household by household, the implications of wealth shocks and changes in Social Security policy on retirement decisions.
- We estimate the impact on economic decisions of a sudden, unexpected shock that results in a 20 percent decline in wealth.
- Since poorer households are less reliant on private savings to finance retirement than are richer households, this decline in wealth has a much smaller impact on their decisions.
- Richer households experience a greater decline in consumption than poorer households.
- The decline in wealth induces households to postpone retirement by one year, on average, with poorer households remaining relatively unaffected; households cut health expenditures, which increases mortality; and households save less than they otherwise would since their lifetime horizon is shorter.
- We estimate the impact of an unanticipated increase in the Early Eligibility Age (EEA) for retirement from age 62 to 64 when households are 55 years old.
- Households decrease their consumption beginning at age 55, especially poorer households, and increase their savings.
- The median retirement age rises to 64 from 62.
- Households spend a little less on medical expenses, and working longer mitigates the adverse consequences for health for most households.
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Paper ID
WP 2012-271Publication Type
Working Paper