Changes in Labor Force Participation of Older Americans and Their Pension Structures: A Policy Perspective

Frank W. Heiland Zhe Li

WP#2012-18

Abstract

We investigate how the shift in private pension coverage from defined benefit (DB) to defined contribution (DC) retirement plans since the 1980s has contributed to the substantial rise in labor force participation of older Americans. We develop a life cycle model of retirement that captures important aspects of private (DB and DC) and public (Social Security Old-Age) pensions. We demonstrate how this novel framework can assist policy makers and researchers in analyzing the complex interrelations of labor supply decisions, retirement behavior, and wealth accumulation. We begin by illustrating important differences in the incentives for labor supply and retirement behavior provided by DB and DC pensions. We show that the timing of the exit from the labor force is closely tied to wealth accrual in DB plans, while wealth accrual in DC plans does not provide similar incentives for the timing of retirement. We then use the model to conduct a cohort-based simulation analysis of labor force participation for the period 1977 to 2010. The results illustrate the potential significance of the rise in employer-sponsored DC pensions in explaining the increase in labor force participation of older Americans. We estimate that, holding the share of individuals with employer-sponsored pensions constant, the shift from DB to DC pension coverage increased the labor force participation rate of workers age 60 to 64 by 4.9 percentage points (1.7 points for ages 65-69). Finally, we show that DC pension holders are more concentrated at the earliest take-up age for Social Security old-age retirement benefits and are less responsive to changes in Social Security retirement age policy than DB pension holders.