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EXECUTIVE SUMMARY
Introduction
Over the past three decades, the distribution of family income has become increasingly less equal. Researchers have identified several trends that have influenced this rising inequality, including a rise in the earnings of more educated workers compared to less educated workers, a rise in relative earnings of older workers compared to younger workers, a rise in the share of single-headed families, and an increase in female earnings in high-income families, among others.
After three decades of rising income inequality, it seems reasonable to infer that retirement income inequality of future retirees will increase. Whether or not this will happen, however, will depend on the extent to which cross-sectional income inequality has and will persist over individuals' lifetimes. It is possible that the increasing disparity of earnings of older and younger workers will have no impact on retirement income inequality, as workers are both young and old over their careers. It is possible that the increase in the share of single-headed families will have little impact on retirement income inequality because of entitlement to Social Security benefits in retirement from former spouses. On the other hand, permanent changes, such as increased returns to education, could result in persistent changes in lifetime earnings. Retirement income inequality will depend on the extent to which families experience both high and low earnings over their working lives and how this variance affects their pensions, savings, and Social Security benefits.
Purpose
This study uses a dynamic microsimulation model to analyze the impact of recent patterns of rising earnings inequality on the retirement incomes of aged cohorts over the next four decades.
This paper addresses the following questions:
- How does the distribution of lifetime earnings change over the next four decades among men, women, and families?
- How do Social Security replacement rates change over time, given changes in earnings, family composition, and Social Security program rules?
- How does the distribution of retirement income change? Here we look separately at Social Security benefits, non-Social Security income, and total retirement income.
- What do these changes imply for poverty rates of the future aged population?
Methodology
This study uses the latest version of the Dynamic Simulation of Income Model (DYNASIM3) to project individual lifetime earnings, taking into account changes in demographics over time. The model also simulates Social Security and pension benefits, asset income, and income of co-resident family members.
The model is based on a sample of more than 44,000 families from the 1990 to 1993 Survey of Income and Program Participation linked to historic earnings records generated from the 1968 to 1994 Panel Study of Income Dynamics and the 1973 Current Population Survey linked with Social Security Administration Summary Earnings Records.
The model simulates demographic and economic events from 1992 to 2040 using a large set of behavioral equations estimated from longitudinal data sources. The results show patterns of average lifetime earnings and per capita and family retirement incomes for cohorts retiring in 2000, 2010, 2020, 2030, and 2040.
Principal Findings
Lifetime Earnings Inequality. DYNASIM3 projects that the inequality in men's lifetime earnings will remain fairly stable over time, while the inequality in women's lifetime earnings will decline considerably. The decline in female lifetime earnings inequality reduces family lifetime earnings inequality over time. Because men's earnings continue to dominate family earnings, the decline in family earnings inequality is not nearly as dramatic as the decline in women's earnings inequality. Family earnings generally are distributed more equally than both men's and women's earnings alone.
Despite dramatic changes in family composition and female earnings over time, family wage-adjusted lifetime earnings will increase only modestly over time. While women's earnings rise relative to the average, some of their gains have come at the expense of men's earnings. While the median of wage-adjusted lifetime earnings of men was historically above the average wage, this is no longer true for men in later cohorts. While women are making substantial gains in the labor market, their lifetime earnings remain below those of men.
The change in the distribution of lifetime earnings are similar to those found by Bosworth, Burtless, and Sahm (2001) based on the Social Security Administration's MINT model. Both models find that lifetime earnings are more equally distributed than cross-sectional earnings. Both models find a significant decline in female lifetime earnings inequality. While DYNASIM3 finds that men's lifetime earnings inequality remains fairly stable over time, MINT predicts that men's lifetime earnings inequality rises slightly over time. The differences in measured inequality are due to differences in the earnings measure, differences in the analysis sample, and structural differences between the models.
Replacement Rates. Social Security replaces less of individual earnings over time, and the gap between men's and women's replacement rates narrows. The replacement rate decline will be more severe for women than for men, as women in later cohorts have more lifetime earnings than earlier cohorts and move into higher lifetime earning brackets (with lower Social Security replacement rates). Furthermore, the increase in the normal retirement age beginning in 2000 reduces the replacement rate for early retirees after 2000 compared to those collecting benefits before 2000.
Family earnings replacement rates (based on shared earnings while a couple is married) decline over time, but not as steeply as individual earnings replacement rates do. Shared earnings replacement rates fall for married couples over time, as increased wives' earnings in dual earner couples are not rewarded with higher Social Security benefits. However, auxiliary benefits still tend to dampen this effect relative to individual earnings replacement rates.
Retirement Income. Average real per beneficiary Social Security income will rise over time, but at a decreasing rate. Changes in the Social Security benefit formula, lifetime earnings, and demographic composition all affect the rate of growth over time. Real non-Social Security income also rises over time. Between 1992 and 2010, non-Social Security income grows faster than Social Security income. After 2010, non-Social Security income grows more slowly than Social Security income. While real Social Security income increases with cohorts as they age, real non-Social Security income and total retirement income both decline. Differential mortality affects both Social Security and non-Social Security income, but the reductions in earnings, asset income, and pension income dominate and cause total retirement income to decline as individuals age.
DYNASIM3 projects that between 1992 and 2000, Social Security income will become more unequally distributed, and between 2000 and 2040, it will become more equally distributed. Non-Social Security income is distributed much more unequally than Social Security income, but it is projected to become slightly more evenly distributed over time. The 80/20 ratio, for example, indicates that real per capita total income will become more unevenly distributed between 1992 and 2010, and then become slightly more evenly distributed through 2040, but at higher levels of inequality than in 1992. For all income sources, there are considerable differences in inequality by gender, marital status, education, and race. Income inequality is higher for women than for men, higher for high school dropouts than for higher-educated individuals, higher for blacks than for nonblacks, and higher for single individuals than for married couples.
Future Poverty. DYNASIM3 projects that poverty rates for individuals at or above the normal retirement age will fall from 12 percent in 1992 to 6 percent in 2020, and to 3 percent in 2040. Although the rates will decline, never-married and divorced women, high school dropouts, and older retirees remain at risk of absolute poverty in the future.
When we adjust poverty thresholds by wage growth rather than price growth, relative poverty rates remain at about 12 percent over the coming decades. Older retirees are still more likely than younger retirees to live in absolute or relative poverty, and single women are more likely than married women and men to be impoverished. Never-married women, high school dropouts, and retirees in the bottom lifetime earnings quintile will have higher relative poverty rates in 2040 than in 1992.
Conclusions
These DYNASIM3 projections show that recent increases in earnings inequality will translate into modest increases in retirement income inequality throughout most of the income distribution. Social Security and female earnings both equalize the distribution of retirement income. Social Security benefits equalize the distribution because of the progressive payment formula. Increased female earnings equalize the income distribution because they pull up the bottom of the distribution, especially among unmarried women in retirement. Increased Social Security coverage rates also make retirement incomes more equal as many low-income noneligible retirees die off.
While increased wage growth, increased female labor force participation, and increased Social Security coverage rates all raise the incomes of future retirees, many historically disadvantaged groups remain vulnerable to poverty. These include the oldest retirees, those with less education, and individuals without access to spousal Social Security benefits.
These projections demonstrate how the complex interactions among recent earnings patterns of men and women, marriage and divorce, mortality, and Social Security policy affect the future distribution of retirement benefits. Women's own earnings will matter more in the future, and spousal benefits will matter less. Persons retiring after 2000 will have lower replacement rates than their predecessors as a result of a 1983 change in Social Security. Any consideration of future changes in Social Security policy must take into account potential effects on retirement income adequacy in the context of a dramatically changing elderly population.
Note: This report is available in its entirety in the Portable Document Format (PDF).
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