A startling number of older adults either lack the cognitive abilities to manage their finances or delegate that responsibility to others — a finding that could have implications for plan executives and other fiduciaries as a wave of wealthy Americans approach retirement.
In a soon-to-be published research paper, “The Age of Reason: Financial Decisions over the Life-Cycle with Implications for Regulation,” David Laibson, a professor at Harvard University, Cambridge, Mass., and noted expert in behavioral economics, found the prevalence of dementia among Americans “explodes” after age 60, doubling every five years to more than 30% of the population over age 85.
Worse yet, many adults without dementia still experience “substantial cognitive impairment,” making it difficult for them to manage their portfolios. Analytic cognitive function, according to the research, falls by about one percentile per year after age 20.
As a result, nearly half of the population between 80 and 89 is impaired by dementia or has cognitive impairment. (The paper was co-written by Sumit Agarwal, senior financial economist at the Federal Reserve Bank of Chicago; John C. Driscoll, an economist at the Federal Reserve Board; and Xavier Gabaix, an associate professor of finance at the Leonard N. Stern School of Business at New York University).
“This is a huge problem, and we're really doing nothing to prepare for the large number of wealthy Americans nearing retirement,” Mr. Laibson said in an interview. “In fact, we've really gone the opposite way, by encouraging and liberating people to take care of their own finances.”
The new research comes as the White House and members of Congress look into possible retirement reforms — from increased fee disclosure to capping equity allocations in lifecycle funds nearing their target dates — as many retirees suffered huge losses in savings during last year's downturn. A Government Accountability Office report late last month concluded that if no action is taken to “make the U.S. private pension system more effective in protecting workers from risks to accumulating and preserving adequate savings for the retirement ... a considerable number of Americans face the prospect of a reduced standard of living.”
There's certainly a lot of wealth at stake. According to the paper, for households with a head age 65-74, the median net worth — including net home equity and excluding public and private defined benefit assets — was $239,400 in 2007. That figure is likely to grow much more quickly in the next three decades as more households go through a full lifetime of accumulating wealth in defined contribution plans, the authors said.