HANOVER, NH - A Dartmouth economist, working with colleagues from Harvard and MIT, has developed projections of future levels of retirement wealth to address what some analysts have called a "perfect storm" of events that threatens the retirement security of future retirees.
"Over the past 25 years, we've seen a fundamental shift in the way Americans save for retirement," says Steven Venti, professor of economics at Dartmouth. "Traditional pension plans based on salary and years of service are withering away while self-directed personal savings plans such as 401(k) plans are growing rapidly. At the same time, the large baby boom population is entering their retirement years. This raises two big concerns. If the retiring boomers all decide to cash out their pensions at the same time, will an asset-selling frenzy lead to a financial market crisis and will the next generation of retirees have enough wealth to retire""
Venti and colleagues James Poterba of MIT and David Wise at Harvard address these questions with a model of the retirement saving sector that accounts for the changing nature of pensions and the aging of the population. Their results suggest that most of these concerns are overstated. They say that 401(k) wealth will continue to grow and that a financial market meltdown is unlikely. Their study was published the week of August 6-10 in the Proceedings of the National Academies of Sciences, or PNAS.
"401(k) assets of current retirees are quite modest because the plans are relatively new and most retirees had only contributed for a few years," says Venti, who also holds the Dewalt H. 1921 & Marie H. Ankeny Professorship in Economic Policy. "Future retirees will have many more years of 401(k) participation under their belts and their accumulations will be substantial. In constant dollars, retirees in 2040 are expected to have five times as much 401(k) wealth as retirees in 2007. Moreover, even as the baby boomers phase into retirement, asset growth generated by the rise of 401(k) plans will more than offset asset declines attributable to the demise of traditional pensions. Overall, the pension sector will not be a major drag on asset markets and a financial meltdown is highly unlikely."
Venti says that some have been critical of the 401(k) savings system, but within the next few years the value of benefits provided by 401(k) plans at retirement will already be greater than the value of traditional pension benefits ever were. He calculates that by 2025 a large fraction of retirees will have contributed consistently for most of their work careers, and this should produce generous retirement incomes.
It's not an entirely optimistic outlook, however. Venti explains that 401(k) plans are almost universal at large employers today, but they are poorly utilized by small employers, and it's difficult to determine whether or how quickly 401(k) plans will diffuse to small employers in the future. This means that not everyone will share in rising retirement wealth. Another uncertainty, he says, is that rates of return may be significantly lower in the future than in the past.
"For our calculations and forecasts, we incorporated projected stock returns three percentage points lower than in the average of the past 80 years, but the possibility of even lower returns exists," he says.
The research was funded by the National Institute of Aging and the Social Security Administration.