The Aging of the Baby Boom Generation

The Impact on Private Pensions, National Saving, and Financial Markets

By John B. Shoven and Sylvester J. Schieber

Introduction: Trends in U.S. Saving
One of the fundamental problems facing the U.S. economy is its low rate of national saving. The concept of national saving may not be widely understood, but fundamentally it is no different than household saving. A household’s saving is defined as income that is not consumed, but rather set aside and invested. Saving is the only reliable way to add to a household’s wealth. The idea is the same for national saving: it is national income which is not consumed and is the only reliable path to faster growth and higher living standards.

A nation’s saving is nothing more or less than the sum of the saving of all households plus the retained earnings of businesses and the net surpluses of federal, state, and local governments (net deficits represent dissaving). Figure 1 illustrates the rate of net national saving in the United States between 1951 and 1995 relative to gross domestic product (GDP). The “net” aspect refers to the fact that this is saving over and above what is necessary to offset depreciation due to the wear, tear, and obsolescence of the existing capital stock. The bars in the figure show personal saving, business saving, and government saving, while the line shows total net national saving relative to GDP.

[Figure 1: Sectoral Saving and U.S. Net National Saving as a Percent of GDP, 1951-1995]

Source: Calculated by the authors from the National Income and Product Accounts

The story is both dramatic and familiar. The net national saving rate in the U.S. economy was fairly stable for the thirty years 1951&shyp;1980, ranging from seven to ten percent of GDP. It has collapsed since 1980 and in the most recent period is roughly three percent of GDP. Personal saving, which includes pension accumulations, fell, as did business saving, and the federal government became a large dissaver.

The actual performance of U.S. saving is even more alarming than this figure indicates, because the appropriate saving rate is probably the amount of saving relative to national wealth or the capital stock rather than relative to one year’s output. Since saving results in a change in wealth, the ratio of saving to wealth is the sustainable rate of growth of the domestically owned capital stock. One constant which economists learn is that the value of tangible assets in the United States (i.e. total national wealth) is about three times either annual national income or GDP. A national saving rate of three percent of GDP therefore translates to a saving rate relative to wealth of only one percent. Since the U.S. population has been growing at that pace, U.S. saving performance has been consistent with complete stagnation in per capita wealth. While there are many other determinants of the growth of real wages, the slow rate of improvement in worker productivity and real wages in this country can almost certainly be explained by the very low rate of national saving.

The Role of Pensions in National Saving

Pension funds are now a very important source of national saving. They have increased from approximately 2 percent of national wealth in 1950 to 24 percent in 1993 (see Figure 2).

In fact, since 1980 the growth in the real wealth in pension funds has been greater than the growth in the real wealth of this country. In this sense, all of the saving in the United States has been accounted for by pensions. However, even within pension saving there have been some signs of weakness since 1980. For example, benefits paid out from pension funds first exceeded employer contributions in 1983; by the late 1980s, benefit payments amounted to more than double employer contributions.

[Figure 2: Pension Assets as a Percent of National Wealth]

Source: Authors’ calculations based on Federal Reserve FOF Balance Sheets.

Two of the reasons that employer pension contributions fell can be immediately identified. First, more than half of the assets in private pension funds are backing the commitments made by employers with defined benefit plans. With this type of plan, employers promise retirement annuities to their employees, with the size of the annuity payments typically determined by years of service to the firm and final pay. The higher-than-expected rates of return on plan assets realized over the last dozen or so years translates quite directly into lower contributions. The second factor reducing employer contributions is the large shift that has been occurring from defined benefit plans to defined contribution plans and 401(k) plans. This shift may have been partly triggered by the regulatory environment facing defined benefit plans, but the point here is that defined benefit plans usually do not involve employee contributions whereas defined contribution plans most commonly do.

Demographic Trends and Retirement Saving

Probably the single largest determinant of the future course of private pension plans as well as the Social Security system is the dramatically changing demographic structure of the American population. The net flows into both the public and private pension system are largely determined by the maturity of the systems and by the number of retirees relative to the number of accumulators. The people retiring today are amongst those in the low birth cohorts of the Depression and World War II. This enhances the saving and cash flows of both the private and public pension systems. Figure 3 shows the working age population relative to the elderly population with two alternative dividing ages, 65 and 70. The numbers shown are not the usual “workers per retiree” numbers which depend on both demographics and labor force behavior. Rather, the numbers are the pure demographic ratios. With either of the two arbitrary ages dividing working age and retirement age, the relative numbers of elderly is shown to be growing dramatically. The change in this ratio between 1990 and 2030 has much to do with the projected bankruptcy of the Social Security Retirement Trust Fund in roughly 2030.

[Figure 3: Working Age Population Divided By Elderly Population]

These ratios are also key for the funded pension system. They indicate the balance of those saving for retirement and those dissaving (withdrawing money) in retirement. Clearly, the demographic ratios of Figure 3 indicate that the private pension system will face an increasing ratio of people collecting benefits to contributors and hence a reduced or negative net cash inflow.

The Future of Pension Saving and Social Security

While the pension system will continue to generate significant investment funds for the U.S. economy for the next 15 years, it is projected to cease being a net source of saving for the economy by 2024 (see Figure 4). In fact, the pension system will then become increasingly a net dissaver, i.e., a net seller of assets. This change of the pension system from a large net producer of saving to a large absorber of saving or loanable funds could have major implications for the future course of interest rates, asset prices, and the growth rate of the economy.

[Figure 4: Potential Real Saving of Private Pensions Relative to Total Private Payroll for the Years 1996-2065 Assuming Current Plan Characteristics and Contribution Rates Persist]

Several factors might offset even the projected subpar returns in 2010-2030. Among the most significant of these factors is the partial privatization of Social Security. A plan such as the “Personal Security Account” (PSA) proposal described in “Social Security Reform Options and Their Implications for Future Retirees, Federal Fiscal Operations, and National Saving” (Schieber and Shoven 1996) would increase the demand for pension assets. The PSA plan would also generate significant net saving for the economy for the long run and even more in the first thirty years or so of the program due to its immaturity (the contributions would start immediately while the first payouts would be small and delayed for roughly seven years). The account balances would likely be several trillion dollars by 2043 and would be generating large saving for the country in the form of return on capital.
Another factor which might go against the reduced returns is the fact that companies can respond to the need for cash by the abundant retired baby boomers by changing their financial policies (e.g. increasing payouts such as dividends and share repurchases and curtailing retained earnings, and investment). Our overall outlook is that the financial markets will cope with the retirement of the baby boomers in such a way that asset returns will be only slightly affected.

Government Policy and Pension Saving

Government policy toward pensions and pension saving has been very inconsistent over the last thirty years. While policies in the 1970s encouraged pension saving, many legislative steps in the 1980s discouraged it. For example, tax rates of up to 99.73 percent can apply to people who save ten percent or more of their compensation over a long career of forty years or more, even if their income is in the range of $40,000 per year. Certainly if these extremely high marginal tax rates become well known, they will significantly discourage pension saving.


The striking thing about the long-term outlook for private pensions and the options available is that the situation is very analogous to that faced by Social Security. The economic and demographic trends are such that the saving and surpluses that the programs are realizing today cannot be sustained without modifying either benefits or contributions. Both funded defined benefit pensions and Social Security require significant adjustments to benefits and/or contributions. In both cases, the sooner these changes are made, the less dramatic they will have to be.

John B. Shoven is Dean, School of Humanities and Sciences, Stanford University; and Sylvester J. Schieber is vice president, Watson Wyatt Worldwide. This paper was prepared for a December 5, 1996, symposium sponsored by the ACCF Center for Policy Research, and will be published in the Center’s forthcoming book, Tax Policy for the 21st Century.