There have been countless reports on the retirement preparedness of Americans; however, existing studies offer conflicting findings on just how financially ready people are to face their non-working years.
A recent brief from the Boston College Center for Retirement Research (CRR) attempts to more accurately answer the fundamental question for retirement security: Will today’s working-age households have enough income to maintain their pre-retirement standard of living?
What CRR researchers found is that existing studies offer contradicting assessments on the level of preparedness among pre-retirees.
On one hand, there is data from the Federal Reserves Survey of Consumer Finances and studies using target replacement rates that indicate a “widespread shortfall.” On the other hand, researchers who use a life-cycle model of optimal savings conclude that most pre-retirees have an “optimal level of wealth.”
“The question is which view best reflects the real world,” CRR researchers write in the brief.
Taking a look at the first methodology, the Fed’s Survey of Consumer Finances shows that the ratio of net wealth to income at each has remained virtually unchanged from 1983 to 2013.
The stability of the ratio, researchers note, reveals a significant decline in retirement preparedness “given that five major developments should have led to higher ratios of wealth to income.”
These five developments include increases that have occurred in life expectancy; the decline of Social Security replacement rates as “Full Retirement Age” moves up from 65 to 67; a shift away from defined benefit retirement plans to 401(k)s; rising retiree out-of-pocket health costs; and real interest rates having fallen since 1983, signifying more wealth is needed to generate a given stream of income.
“The stability of wealth-to-income ratios over the 1983-2013 period clearly indicates that people are less well-prepared than in the past,” researchers wrote. “If they were over-prepared in the past, they could be fine today. But if they were not over-prepared in 1983, then they are falling short today.”
Another source of conflicting studies on retirement preparedness today involves two different approaches used in calculation methodology: one that uses target replacement rates, and another that relies on an optimal savings model.
The target replacement rate approach compares projected replacement rates—retirement income as a percentage of pre-retirement income—for today’s working-age households to target rates that would allow them to enjoy the same consumption in each period before and after retirement.
In 2013, the most recent results available, 52% of all working-age households from ages 30 to 59 are at risk, compared to 53% of households at risk in 2010; 44% in 2007; and 43% in 2004.
Contrasting this method, the optimal savings approach concludes that most Americans are accumulating more than enough to “smooth the marginal utility of consumption over the life cycle.”
In this particular model of wealth accumulation and decumulation, mortality, labor market, health cost risk and income from defined benefit pensions and Social Security are incorporated to calculate the wealth that households should have accumulated by their 50s. These “optimal amounts” are then compared with the amounts that households actually accumulated.
Using this model, researchers found that in 2004, only 8% of households in their 50s had less than optimal wealth, far below the comparable figure of 35% for the National Retirement Risk Index.
While the issue remains unsettled of which study methodology better reflects today’s retirement preparedness, of all the studies, CRR researchers come to the conclusion that the most convincing evidence about retirement prep is the calculation of wealth-to-income ratio from the Fed’s Survey of Consumer Finances.
“These ratios have remained unchanged over time despite several developments that suggest they should have increased,” researchers write. “Thus, we are not surprised that calculations involving target replacement rates show that about half of households will be unable to maintain their standard of living in retirement.”
View the brief.
Written by Jason Oliva