By James Kwak
James Poterba wrote up a very useful overview of the retirement security challenge in a new NBER white paper. (I think it’s not paywalled, but I’m not sure.) He provides overviews of much of the recent research and data on life expectancies, macroeconomic implications of a changing age structure, income and assets of people at or near retirement, and shifts in types of retirement assets.
In the past, I’ve used the Federal Reserve’s Survey of Consumer Finances as my source for data about the inadequacy of many households’ retirement savings. Poterba has a new, perhaps even more stark snapshot:
You have to read down the columns, not across the rows. That is, the first row doesn’t give you the financial picture of the 10th-percentile household. Instead, it gives you the net worth of the 10th-percentile household by net worth, the present value of Social Security benefits for the 10th-percentile household by Social Security benefits, and so on.
Still, it’s eye-opening. It says that 50% of households have personal retirement accounts worth $5,000 or less; 50% of households have other financial assets of $15,000 or less; and 50% of households have no defined benefit pensions. 30% of households have total wealth, not counting annuitized pensions, of $72,000 or less. As of late last year, a 65-year-old woman buying a life annuity with a 3% annual escalation clause would get 3.7% of her up-front payment per year (Table 15), so $72,000 in wealth would generate just $2,664 per year—and that’s assuming she finds a way to liquidate her home equity (often the main source of wealth for people in the low-to-medium wealth tiers). And these data are from the 2008 Health and Retirement Survey, so they are only partway down from the housing market peak of late 2006.
These figures might not be so worrying if defined benefit and defined contribution plans turned out to be substitutes for each other—that is, if households without DC plans tended to have DB plans and vice versa. But that doesn’t seem to be the case. First, 26% of households headed by individuals aged 55–64 have no retirement plan at all, and 37% have only one plan (DC, DB, or IRA). Second, it turns out that the more retirement plans you have, the more you tend to have in each one; for example, people who have IRAs, DC plans, and DB plans have higher balances in their DB plans than people who have fewer plans (Table 13).
The overall picture is that the combination of income inequality and a retirement system that largely caters to high-income workers (for example, through tax preferences that disproportionately benefit people in high tax brackets who can afford large retirement contributions) has created vast inequality in retirement preparedness. Poterba does some back-of-the-envelope calculations indicating that people will most likely have to save a lot more than most people are saving today if they want to enjoy decent replacement rates in retirement.
This is true as an arithmetic point, but of course your ability to save depends more than anything else on your income. Absent some form of lifetime income risk sharing (like Social Security), it’s not clear there is a solution for people near the bottom of the income distribution.