The Composition and Drawdown of Wealth in Retirement

As the “baby boomers” approach and enter their retirement years, the accumulation phase of their life-cycle is nearly over. Thus, the focus of many researchers, financial services firms, and public policymakers concerned with retirement saving is shifting from the accumulation of resources while working to the drawdown of resources during retirement. Retired households are dependent on the annuitized income streams that they have built up during their working careers and on the wealth that they have accumulated in other forms. The two most common annuitized income streams are Social Security benefits and the payments from defined benefit pension plans. These payout streams provide income for life—and thus provide some protection against falling into poverty if one lives an especially long life. The three most common sources of accumulated wealth are equity in an owner-occupied home, financial assets such as bonds and stocks, and financial assets held in a personal retirement account such as an Individual Retirement Arrangement or a 401(k) plan. Throughout our analysis, we will define “retirement-age households” as those headed by someone between the ages of 65 and 69. In 2008, just over 80 percent of these households had some equity in their home or another property, while 52 percent had assets in personal retirement accounts. A much higher fraction—87 percent—had some financial assets outside their retirement accounts, but for many households the amount of such assets was relatively modest. Only 45 percent had more than $20,000 in non-retirement-account financial assets. The median financial asset holding for this group, including holdings in personal retirement accounts, is $52,000. In short, many households have small enough amounts of accumulated wealth that they will depend heavily on the life-contingent payout streams offered by Social Security and, if they have one, a defined benefit pension. This paper presents evidence on the resources available to households as they enter retirement. It draws heavily on data collected by the Health and Retirement Study, which we sometimes refer to as the “HRS.” We calculate the “potential additional annuity income” that households could purchase, given their holdings of non-annuitized financial assets at the start of retirement. Even if households used all of their financial assets inside and outside personal retirement accounts to purchase a life annuity, only 47 percent of households between the ages of 65 and 69 in 2008 could increase their life-contingent income by more than $5,000 per year. At the upper end of the wealth distribution, however, a substantial number of households could make large annuity purchases. We also consider the role of housing equity in the portfolios of retirement-age households and explore the extent to which households draw down housing equity and financial assets as they age. We find that many households appear to treat housing equity and non-annuitized financial assets as “precautionary savings,” tending to draw them down only when they experience a shock such as the death of a spouse or a period of substantial medical outlays. Because home equity is often conserved until very late in life, for many households it may provide some insurance against the risk of living longer than expected. A brief conclusion summarizes our findings and indicates how they bear on a number of policy issues, such as the role for annuity defaults in retirement saving plans.