How Well Prepared Are Americans for Retirement?

The following guest post was contributed by Andrew Biggs. He has studied the issue of retirement savings for a couple of orders of magnitude longer than I, so I wanted to give him the opportunity to outline his perspective on the topic. He regularly blogs on his own blog and, along with about four dozen other people, over here.

After our exchange regarding Tuesday’s blog on The Retirement Problem in the Washington Post (which started over at AEI’s Enterprise blog and continued here),  James generously offered to let me guest-post my thoughts on Americans’ level of preparation for retirement. Overall I’m not so pessimistic, although there are surely problems that must be addressed. But most of the detailed research out there points to problems, but not a crisis.

Both James’s analysis and my own response were built on relatively simple projections using stylized workers who pay into Social Security and participate in 401(k) plans. These illustrations are useful for fleshing out basic issues – plus, in this case, finding how the SSA’s online benefit calculator may have skewed some of the results.

But the best research on retirement preparedness is more involved than this. Most analysis of current retirees uses survey data, such as from the Health and Retirement Study (HRS), the Survey of Income and Program Participation (SIPP), the Fed’s Survey of Consumer Finances (SCF) and the Current Population Survey (CPS). Each survey has strengths and weaknesses.

In addition, broader models of the population are built using this survey data. These models allow for simulations of how policy changes affect current retirees, as well as projecting the population into the future. Such comprehensive models include the Social Security Administration/Urban Institute MINT (Modeling Income in the Near Term) model, the Congressional Budget Office’s CBOLT (CBO Long Term) and the Policy Simulation Group’s PSG suite of models, used by the Government Accountability Office and the Department of Labor for Social Security and private pension projections. While these models, like any others, rely on assumptions regarding a large number of factors, they are also the most closely scrutinized to ensure these assumptions are consistent with current trends.

I’ll first run through what some of my own work has found, and then highlight some work from elsewhere. This paper, written with Glenn Springstead when I was at SSA, used the MINT model to analyze replacement rates for current retirees and, using projected data, for individuals retiring in the 2040s. We looked at income from a wide variety of sources, including Social Security, defined benefit and defined contribution pensions, earnings, co-resident income and government programs such as SSI. We examined individuals aged 64-66 in 2005 and projections for individuals aged 64-66 in 2040. The typical couple in 2005 had total retirement income equal to 185% of final earnings, while the median projected couple in 2040 has a replacement rate of 131%. Now, these are projections, but bear in mind that the MINT model is probably the most comprehensive and best-vetted projection model of retirement income, with a large number of economists, demographers and social scientists working on it and regularly assessing its results.

As second paper used the Policy Simulation Group models, which look only at Social Security and private pensions. In this paper I used a different definition of replacement rates and also adjusted replacement rates to account for differences in household size and the number of children. (Larger households have economies of scale; children consume income during working years that doesn’t need to be replaced in retirement, so childless couples would need to save more for retirement than couples with children.) Here I looked at people born in 1940 and 1960 to track replacement rates from today through the 2020s. The median Social Security/pension replacement rate for the 1940 cohort was 92 percent while the median for the 1960 cohort was 82 percent. Working just an additional year would bring the 1960 birth cohort up to 1940 levels. While replacement rates do decline over time, due to a rising Social Security retirement age and declining DB pension coverage, most people at most income levels are doing ok.

This well-received paper by John Karl Scholz and Ananth Seshadri of the University of Wisconsin–Madison and Surachai Khitatrakun of the Urban Institute uses the HRS to examine how well the Baby Boomers are prepared for retirement. It uses a more sophisticated measure of retirement readiness than the replacement rates I used, but the basic idea is similar. They find that

over 80 percent of HRS households have accumulated more wealth than their optimal targets. These targets indicate the amounts of private saving households should have acquired at the time we observe them in the data, given their life cycle planning problem and Social Security and defined-benefit pension expectations and realizations. For those not meeting their targets, the magnitudes of the deficits are typically small.

In a draft follow-up paper Scholz and Seshadri reach similar conclusions for younger cohorts.

Now, there have been good research projects that have come to alternate conclusions, the most prominent being the National Retirement Risk Index generated by the Center for Retirement Research at Boston College. Without doing a very detailed nuts-and-bolts comparison of the CRR’s model to the others it’s hard to say exactly what’s driving the differences. While I really like the CRR’s work, I would say that models like SSA’s MINT are more comprehensive and have been around longer, so I would tend to favor those results. CRR’s model was built for the NRRI research project and I’m not sure its general results fully match those from other models.

None of this is to say retirement preparation doesn’t face problems. DC plans like 401(k)s present challenges to savers and both participation rates and asset management haven’t been as good as we’d like, although policies to address both problems are being implemented. Likewise, Social Security is almost sure to reduce benefits in the future, at least for middle and high earners, and Americans will need to save more to make up for these losses. But the key is to look closely at who’s unprepared for retirement, why, and what we should or can do about it. When we think about a “crisis” in retirement saving, hasty solutions might make things worse rather than better.

By Andrew Biggs

19 responses to “How Well Prepared Are Americans for Retirement?

  1. not so convinced that 401ks aren’t a joke. they only work in good times. in bad they are hopeless. having individuals (while working) trying to manage their 401ks is like having an airline pilot use a laptop while flying. and i think we know how that turned out don’t we? workers don’t have the time to manage the money, even if they had the knowledge to do so. and then there is the fee problem. most 401k funds have high fees, and the employer has no incentive to control those (as a result most don’t). and this leads to the funds being managements best friends because if they get their funds into 401ks they have a gravy train of money

  2. I was on course when I was 40. Good chunk of change saved. Working in a great position as a software engineer. Then, the dot com era crashed, and that hurt the savings a bit. Next, I was l laid off, and had to use those “retirement” savings to stay alive.

    Now, I’m 48. No longer a software engineer, because no one hires 48 year old software engineers, no matter how good (and the gap in employment is a killer, the skills move quickly and if you’re not employed, you don’t get the experience.) Savings are gone. Debt is up.

    Retirement? I figure I’ll need to be working when I’m 90. If I live so long.

  3. Wasn’t the main purpose of the 401k system to be a supplement retirement plan for executives? Reasonable installments from ‘normal’ folk can’t match the volume of the intended target participant. Was the 401k system ‘pushed’ to the rest of the populace by the investment establishment who saw a new source of money (when all of the ‘small’ accounts are added up you have a large influx of cash)?

    Just with this in mind, the calculations earlier this week are just proof the 401k system really wasn’t intended for all.

  4. I have no data but it seems to me that too many people feel they have too few resources to save properly for retirement (or truly do not have the resources); people are spending to maintain what they perceive, rightly or wrongly, as a middle class lifestyle or just to stay afloat. Americans no longer have this idea that they are struggling immigrants who need to save all they can to provide for the next generation.

  5. Debt…………12 trillion
    Social Security.18 trillion
    Medicare A……37 trillion
    Medicare B……37 trillion
    Medicare D……16 trillion
    TARP/TALP/PPIP..11-22 trillion
    2 Wars………. 2 trillion

    1,028% more than we earn.

    The USDX is going to test the .71 level of support and gold is above $1,100.00.

    Retirement? That is like standing on a train track and discussing dinner and a movie as the train speeds towards you.

  6. “The typical couple in 2005 had total retirement income equal to 185% of final earnings, while the median projected couple in 2040 has a replacement rate of 131%”?

    I’m not certain what this means (if anything). For example, what is the income and asset profile of this ‘typical couple’? How much of its ‘retirement income’ depends upon social security? What are this ‘typical couple’s’ other sources of retirement income? How much depends upon the equity casino which remains hostage to the dollar carry trade and OTC derivatives leverage? As a member of the age group which retired in 2005, I have watched my non-social security income fall from quite comfortable at that time to roughly zero under the Fed’s zero interest rate policy.

    The only people living comfortably on Social Security are working for Social Security.

  7. Regarding assets, I have two charts that may inform this discussion:

    http://finance.yahoo.com/q/bc?s=%5EN225&t=my&l=off&z=m&q=l&c=

    and

    http://www.generationaldynamics.com/ww2010/g070219b.gif

    Couldn’t happen here? As the Spartans said: “maybe.”

    Couple those charts with a war on savers via ZIRP/QE, american’s inability to save more than 5% of their income and growing debt servicing costs.

    I see little reason for optimism.

    Cheers,
    Carson

  8. Why save? Social Security will eventually be means tested which implies that those who saved all these years and have a cushion will be deem to receive less SS benefits. Better to hide any wealth in trust for the children

  9. Mr. Andrew Biggs was nice enough to contribute to “Baseline” so he has a certain amount of civilness and kindness. Therefor I will bite my tongue about what I think of many of the other “people” who work at the American Enterprise Institute (AEI).

  10. Just read Mr. Biggs piece. I don’t have charts or graphs but as an almost 60 year old financial professional I don’t understand where he gets his information? It is totally contrary to my personal financial position and expectations and doesn’t jive with anything I’ve read or anecdotally heard from friends and acquaintances. I guess if our example is a working couple in the private sector (maybe govt sector pension employees skew the data?) had two children or less, was reasonably frugal, did not experience any significant job loss or health emergency during their careers and worked until they are 65 or 70, they should be OK.

  11. not sure we ever thought that in at least a century. or more. the next generation wasn’t even a thought in the past. go far enough back and just surviving was the all that we could think of. and retirement was only for the rich

  12. have you checked what the non federal debt looks like? it makes all the number for it look like pocket change.
    and considering that we own that debt on a much shorter term that the government does.
    estimated of medicare are notoriously unreliable. cause we have no idea how many will need care (and thus cost) nor do we how much the care will cost (except that with no change it will be much higher than today. medical inflation has been at 5% or more, even now)

  13. The British Invasion of 2009. What is your fascination with our economy, British people formerly of Oxbridge/LSE?

    Simon, Peter (sort of), Andrew, here. Felix over at the evil Reuters. Scores more if you look carefully. This does not seem to be a reciprocal arrangement. Do you have american pundits manipulating opinion, and perception of threat levels, back in Albion and environs?

  14. The Scholz-Seshadri paper, demonstrating that 80% of boomers have surpassed their retirement targets and the others are only marginally behind, was written in 2006! Of course retirement portfolios look fantastic if you don’t take into account the last three years! And their follow up in 2008 again ignores the nearly 50% decline in equities (which boomers’ 401k shouldn’t have much invested in, but many, it turns out did) between 4Q08 and 1Q09. Of course things may have turned around for those who, after watching the markets crash and burn, dumped what was left of their savings into soon to be inflated equities (P/E over 120 anyone?), but that is an irrelevant minority. The reality is that most retirement portfolios shrank significantly in the last 15 months, certainly decimating the rosy estimates in the aforementioned papers.

    I agree Mr. Biggs, Americans’ preparedness for retirement doesn’t look so bad when you ignore current realities. (That makes you qualified for congress in the good old US of A!)

  15. In The Great 401k Hoax, the authors argue that the real ROI is 1.8 percent, over the long haul. Thank God Bush wasn’t able to privatize Social Security.

  16. I second the motion on being thankful Bush couldn’t privatize Social Security. As for retirement, it came to me early in the form of disability retirement. After working for 30 years, I am so lucky to have been in a pension system through work (school district) and through social security. I have an IRA, but watching it fall to half it’s value in the dot.com bust, I was lucky to use part of it to buy a house. The rest of my savings have gone to pay off the mortgage. The house next to mine was just sold for only $10,000 more than I paid for mine 7 years ago. I guess I’ll live here forever. House prices could keep dropping. I’m happy I can afford to make my health insurance premiums, buy food, pay utilities and such. No big luxuries in my life, but thankfully, I don’t have much debt either. I count myself among the lucky, even if I do have to deal with a chronic pain condition that stopped me from working. I can deal with the physical pain, because I know how to handle it. The unknown variables that keep being thrown at us are harder to manage.

  17. «if our example is a working couple in the private sector (maybe govt sector pension employees skew the data?) had two children or less, was reasonably frugal, did not experience any significant job loss or health emergency during their careers and worked until they are 65 or 70, they should be OK.»

    More precisely, government workers or union workers with a safe defined pension, who bought their house cheap many years ago, and bought their stocks cheap over 25 years go, and have sold them at the peak of the bubble, are going to do well.

    Otherwise I cannot see how “The typical couple in 2005 had total retirement income equal to 185% of final earnings, while the median projected couple in 2040 has a replacement rate of 131%.”, unless the 185% and 131% refer to non-inflation-adjusted income. Retire on nearly double their *final earnings*?

    There are more comprehensible figures here:

    http://www.usnews.com/money/blogs/planning-to-retire/2008/7/1/are-your-retirement-savings-on-target.html
    «Human resources consulting firm Hewitt Associates released a report today saying that employees will need to replace, on average, an astonishing 126 percent of their final pay in retirement after inflation and medical costs are factored in. Most workers are on target to replace 85 percent of their income based on Hewitt’s analysis of nearly 2 million employees at 72 large U.S. companies.»
    «Social Security replaces, on average, 54.2 percent of wages for low-earning workers and 33.5 percent of income for high earners. To get to, say, a 75 percent replacement rate, you’d have to make up the difference of only 20.8 and 41.5 percent of income, respectively. And if you’re lucky enough to have a pension, you can probably get by with saving even less.»
    «Workers between 55 and 64 who have a 401(k)-style plan had a median account balance of $50,000 in 2004, which would provide an income of about $4,400 per year, replacing just 9 percent of income, on average, the GAO calculated.»

    Note the fantasy of $4.4k/y during retirement for people who have $50k on average 5 years before retirement.

  18. Actaully Medicare is not as bad off as most think. In 1984 a statute was passed to keep both Social Security and Medicare from consuming all federal revenues. By statute, both programs are limited to spending only what is in their respective trust funds, dedicated tax revenues and interest paid on their trust funds. By statute, neither may borrow any funds to pay benefits.

    This statute also requires SS trustees to file promptly with congress their recomendations for correcting any imbalance that causes the trust fund to fall below 20% of any given years projected expenses.

    For those who have been receiving SS benefit statemetns for 12 years, in everyone they say the trust fund will be exhausted. This is less than the 20% trigger point. Where is this prompt report to correct the imbalance?

    By law if nothing is done, across the board take place.

    With Medicare it is a bit different. 50% of Medicare’s funding comes from the payroll tax. 25% comes from beneficiaires in the form of premiums, co-pay and deductibles. 25% is paid from General Revenues. Since these identified rates are identified in statute, they cannot be changed unless congress changes them. So let us say congress keeps this identified split. This means that Medicare expenses will be capped at a maximum of 5.8% of payroll period.

    What that means for Medicare is this: Medicare is dipping into its trust fund, thereby spending far more than 5.8% of payroll which it is allowed to do using its dedicated trust fund. However, when the trust fund is exhausted, there will be a dramatic cut in Medicare Spending in the range of $100 billion a year. Instead of spending $400 billion in decicated payroll tax plus $100 billion in trust fund, it will be reduced to $400 billion or 5.8% of payroll.

    Also, keep in mind that COLA replaces those basket of goods available to the beneficiarie based on the year they turn 60. Any new products that come out after year 60 is not in their basket of goods. If you want to maintain a standard of living instead of being able to buy the same goods available when you turned 60, requires a lot more. Too many are trying to maintain their standard of living on COLA instead of maintaining their buying power for that basket of goods that were available when they turned 60.

    As for the National debt, the last general budget surplus was in 1957. Looking at the interest paid on the debt till 2005 shows that the entire increase in debt of $271 billion to over $5.5 Trillion is due to interest alone. I have not looked at the interest paid on the debt since 2005. Every single stimulas passed by congress since 1957 has never been paid back and the interest paid on this borrowed money has been borrowed itself.

    Teh greatest generation has left the greatest debt in the history of mankind.

  19. I am not at all prepared for retirement, but I generally don’t prepare myself for things I don’t plan to do.

    One thing about all of this retirement talk that always bugs me is the assumption that retirement is as certain as death and taxes, and we damn sure better be prepared for it. I am in my mid-40s and I do not plan to retire unless I am physically or mentally unable to work. This whole obsession with retirement seems to me to be a (rather succesful) marketing ploy pulled off by the people who make money off of retirement planning.
    What am I missing here?