Uncertainty, Expectation Bias Beset Retirement Savers

A recent study examines individuals’ choices concerning saving for retirement and assesses non-retirees’ subjective expectations—and finds that they have significant biases and uncertainty about their retirement benefits.

 

In “Subjective Expectations, Social Security Benefits, and the Optimal Path to Retirement,” Maria Prados, an economist at University of Southern California’s Center for Economic and Social Research, and Arie Kapteyn, an economics professor and founding director of the University of Southern California Dornsife Center for Economic and Social Research, conducted a study for the University of Michigan’s Michigan Retirement and Disability Research Center. They sought to better understand the importance of retirement expectations in savings decisions and retirement income and in forecasting future benefits.

Prados and Kapteyn found that employees’ uncertainty and their level of subjective expectations can affect their readiness to retire. They find that the greater the uncertainty, the less the retirement readiness. “We find that these biases in subjective expectations translate into suboptimal asset accumulation and welfare losses,” they write. They report that the discrepancy between subjective expectations and the rational expectations can hurt wealth accumulation and loss of future benefits.

 

Prados and Kapteyn found that “most individuals face significant uncertainty” about their Social Security benefits and that they tend to overestimate what they will receive.

Furthermore, they found that most retirees discover their Social Security retirement benefits are lower than what they had expected before they claimed them.

 

Higher uncertainty about future retirement benefits leads to higher expectations bias and a higher likelihood of overestimating future benefits, Prados and Kapteyn found. They warn that choices based on subjective expectations about future retirement benefits can lead to high consumption during the working years, and too little asset accumulation. They result, they say, is that such individuals will not be able to consume what would be optimal during their retirement.

 

Less likely to overestimate future retirement benefits, Prados and Kapteyn say, are men and those with low uncertainty about retirement benefits. They conclude that such individuals “are more likely to save more and reach retirement better prepared.” Age is also a factor, the study indicates. Prados and Kapteyn found that uncertainty about retirement benefits, as well as the likelihood of overestimating retirement benefits and the level of expectation bias, decrease with age.

 

Lack of knowledge has an effect as well, Prados and Kapteyn say. They also found that those who say they know nothing about their future benefits have much lower expectation bias and are more likely to underestimate their retirement benefits. But they also say that lack of accurate knowledge about Social Security benefits that will come can exacerbate the effect of subjective expectations. And they found that about half —49%— of respondents said they had no knowledge about how much their benefits will amount to.