5 Things You Need to Know About Retirement Readiness

Recently the Government Accountability Office (GAO) released a report titled with its conclusion: “Most Households Approaching Retirement Have Low Savings.”

The title was no surprise — though the definitions of “most” and “low” bear further understanding.

The GAO Analysis
The GAO based most of its conclusions on findings from the 2013 Survey of Consumer Finance (SCF), conducted by the Federal Reserve every three years. It is a reputable and well-regarded source of consumer information, drawn from a sampling of about 6,000 households (different ones every cycle). That said, the information contained is “self-reported,” which is to say that it tells you what the individual thinks they have (or perhaps wishes they had), but not necessarily what they actually have. More on that in a minute.

The rationale for the “most” in the headline appears to come from its focus on households age 55 and older, where the GAO noted that (only) 48% had some retirement savings, and thus one might reasonably assume that the remaining 52% had no retirement savings — and that would seem to be the case. However, 23% of that 52% said they had a defined benefit plan. Now, that assessment may be inaccurate (see above), but if they do, in fact, have a DB plan, that plus Social Security might well be sufficient. So, “most” have no savings, but about half of that “most” might not need savings. Admittedly, that distinction makes for a clumsy headline.

What about the 29% who were age 55 or older, and who had neither a DB plan nor retirement savings? Well, the median annual income of that group was (just) $18,932. It’s not hard to imagine why that income bracket might not have set aside any savings for retirement. On the other hand, that group is probably well served by Social Security. Despite that income level, more than a third (35%) of those in this group say they own a home with no debt. Assuming that is the case (see “self-reported” above), that could make a big difference in their post-retirement expenses and/or represent an additional resource they could draw on for retirement income.

The GAO conclusions notwithstanding, here are five things you need to know about retirement readiness (and retirement readiness projections):

1. Social Security matters — especially for lower-income individuals.
Social Security remains the largest component of household income in retirement. In fact, GAO noted that for households age 65-74 with no retirement savings, Social Security makes up 57% of their household income on average. In fact, a quarter of this group rely on Social Security for more than 90% of their income.

For all households age 65-74, median annual income is about $47,000, and Social Security makes up on average 44% of income for households in this age group, larger than any other income source. About 90% of all households in this age range receive some Social Security income, and the median amount they receive is approximately $19,000.

The median income for households age 75 and older is about $27,000, and the median Social Security income is approximately $17,000. In fact, when compared to younger households age 65-74, Social Security makes up a larger share of household income for retirees age 75 and older, with 62% of these households relying on Social Security for more than 50%, and more than one-in-five (22%) relying on Social Security for more than 90% of their income.

2. Average or even median savings amount in the abstract tell you very little about retirement income adequacy at an individual level.

People live in different places and have different lifestyles and lifestyle expectations. They may have resources available beyond that reported in surveys such as the SCF, and individual health circumstances can make a huge difference in the adequacy of reported income sources vis-à-vis actual retirement spending requirements.

3. Pre-retirement income (or a percentage thereof) may not be a reliable proxy for post-retirement needs.

Many of these studies — and those cited by the GAO were no exception — use a “replacement rate” standard which, while it may be a convenient metric to use to convey retirement targets to individuals, has some serious shortcomings when applied to these large-scale policy models for determining whether an individual will run short of money in retirement.

The reality is that what and how we spend money pre-retirement often has little to do with our actual financial needs post-retirement.

As EBRI’s Research Director Jack VanDerhei points out, “…simply setting a target replacement rate at retirement age and suggesting that anyone above that threshold will have a ‘successful’ retirement completely ignores longevity risk, post-retirement investment risk, and long-term care risk.”

4. Many retirement projection models assume a 50% probability of success.
Aside from the shortcomings inherent in relying on a replacement rate for these projections, if you try to factor in longevity risk (the risk of running out of money in retirement), and post-retirement investment risk, VanDerhei notes that if you use a replacement rate threshold based on average longevity and average rate of return, you will, in essence, have a savings target that will prove to be insufficient… about 50% of the time.

Of course, when it comes to their retirement security, individuals tend to prefer something much closer to 100%.

5. Those who have a retirement plan are much better off than those who don’t.
Those with no retirement savings had a median income of approximately $29,000, while those in the same age range who have some retirement savings have a median income of $76,000. Among those age 55-64 with no retirement savings, the median net worth was $21,000 (about half of these had no wage or salary income), while among those in the same age bracket with any retirement savings, their median net worth was $337,000. In that group, the median income of those with no retirement savings was $26,000; among those with some retirement savings, the median income was $88,000.

Compared to those with retirement savings, these households (those aged 55-64 with no retirement savings) have about one-third of the median income and about one-fifteenth of the median net worth, and are less likely to be covered by a DB plan.

All of which suggests that it would probably be more meaningful to examine the retirement readiness of those without access to a retirement plan separately from those who do.

- Nevin E. Adams, JD

Model "Hones"

After a winter filled with predictions of winter weather that never quite measured up to the forecasts, the nation’s capital (and the Southeast) finally got a taste of what those in the Midwest and Northeast have been contending with for weeks.  Not that there haven’t been close calls here, but up until this week, the multitude of factors that have to come together to produce a significant snowfall here—hadn’t.  Much to the discomfiture of those who ply their trade making such predictions, it should be noted.

While Mother Nature can be notoriously fickle, technologies like Doppler radar are able to discern with greater precision real-time activity which can be fed into sophisticated computer models that draw on the experience of the past to extrapolate a series of potential outcomes—some deemed more likely than others.  Projected outcomes that, despite the recent experience here, do an increasingly accurate job of helping each of us plan our daily commute or that vacation a couple of weeks hence.

Arguably, predictions about retirement readiness are even more complicated than weather forecasting, though there are certain similarities.  Done properly, they require a foundation in knowing the actual resources available to individuals—and an ability, through the use of sophisticated computer models, to forecast the impact of current behaviors on future outcomes.  Those models must also consider the likelihood and timing of certain external factors, and their impact on resources, and to project if (or when) those resources will run short against lifespans and circumstances as unique and variable as the American population.

Of course, those computer models require updating on a regular basis to properly account for changes in assumptions (and realities).  A recent EBRI Issue Brief[1] noted that, due to the increase in financial market and housing values during 2013, the probability that Baby Boomers and Generation Xers would NOT run short of money in retirement increased between 0.5 and 1.6 percentage points (when aggregated by age cohort), based on the Employee Benefit Research Institute (EBRI) Retirement Readiness Ratings (RRRs).[2]

EBRI’s analysis, which analyzes the major factors that cause retirement outcomes to differ, and their impact, found that, among other things, eligibility for participation in an employer-sponsored 401(k)-type plan remains one of the most important factors for retirement income adequacy.  In fact, Gen Xers in the lowest-income quartile with 20 or more years of future eligibility in a defined contribution plan are half as likely to run short of money as those with no years of future eligibility.

Not surprisingly, the report also noted that the risks of a long life and high long term-care costs drive huge variations in retirement income adequacy—and suggested that annuities and long-term care insurance could mitigate much of the variability in retirement income adequacy at or near retirement age.

Of course, while a broad-based forecast is sufficient for the local weather, and a broad-based sense of the nation’s retirement readiness is powerful fodder for purposes of setting public policy goals, individual forecasts—in order to be accurate—require more customized inputs.[3]  

Nevin E. Adams, JD

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[1] “What Causes EBRI Retirement Readiness Ratings™ to Vary: Results from the 2014 Retirement Security Projection Model®” is available online here.

[2] EBRI’s proprietary Retirement Security Projection Model^® (RSPM), unlike many other models, takes into account a combination of deterministic expenses from the Consumer Expenditure Survey (as a function of age and income) as well as health insurance and out-of-pocket, health-related expenses, plus stochastic expenses from nursing home and home-health care (at least until the point such expenses are covered by Medicaid).  A chronology of the EBRI Retirement Security Projection Model^® is available online here.  

[3] Fortunately, individuals who want a sense of their retirement readiness can check out EBRI’s BallparkE$timate,^® along with the other materials available at www.choosetosave.org

"Common' Sense

At a time when the nation’s legislative wheels seem mired in partisanship, the last week of January turned out to be a busy one for retirement plan proposals.

First the president unveiled his myRA concept in the State of the Union (along with a reference to an automatic IRA proposal previously included in the White House’s annual budget), followed a day later by introduction of the Retirement Security Act of 2014, a bipartisan proposal by Sens. Bill Nelson (D-FL) and Susan Collins (R-ME). A day after that, Sen. Tom Harkin (D-IA), chairman of the Senate Health, Education, Labor, and Pensions (HELP) Committee, formally introduced the Universal, Secure, and Adaptable (USA) Retirement Funds Act of 2014, an updated version of his 2012 proposal.

All three were intended to expand and improve the retirement savings of Americans—although, as you might expect, the three take quite different approaches. Consider that the myRA calls for the development of a “new retirement savings security” to encourage savings in a kind of Roth IRA, while Sen. Harkin’s proposal would require employers above a certain size to offer a whole new type of retirement savings plan (and would impose some new threshold enrollment and withdrawal requirements on existing 401(k)s, as well). As for the Nelson/Collins proposal, it seems to be largely focused on lowering or removing certain current regulatory and administrative barriers to smaller employers offering retirement plans.

Despite their varied approaches to the commonly-stated goal of expanding retirement savings, all three do have one other key commonality: All look to leverage the success of the work place and systematic payroll deductions in fostering retirement savings. Of course, that’s a foundation whose worth previous EBRI research has documented:¹ the impact that eligibility for a work place retirement plan can have on retirement readiness,² as well as the additional help that automatic-enrollment designs can provide.

It remains to be seen whether the legislative proposals will go anywhere—and the potential impact of myRA on motivating new savers is also uncertain. Just this week, Senate Majority Leader Harry Reid (D-NV) introduced a proposal on defined benefit pension smoothing—not to provide any kind of help for retirement, but as a way to pay for a three-month extension of unemployment benefits.

But as America Saves Week nears, the activity on Capitol Hill serves as an additional reminder that a good place to start—any time, with or without the incentives of legislative change—is to Choose to Save. ®³

Nevin E. Adams, JD

¹ The January EBRI Notes, “The Role of Social Security, Defined Benefits, and Private Retirement Accounts in the Face of the Retirement Crisis,” is available online here.

² See “The Impact of Automatic Enrollment in 401(k) Plans on Future Retirement Accumulations: A Simulation Study Based on Plan Design Modifications of Large Plan Sponsors,” online here, and “Increasing Default Deferral Rates in Automatic Enrollment 401(k) Plans: The Impact on Retirement Savings Success in Plans With Automatic Escalation,” online here.

³ You can find a wide variety of tools and resources—including the popular and widely recommended Ballpark E$timate—at http://www.choosetosave.org/

Safety "Net"

I’m one of those travelers who absolutely dreads cutting it to the last minute. Not that I haven’t been forced to do so, from time to time, but I’m generally the one chomping at the bit to get to the airport, or to hit the highway an hour before anyone else. In my defense, on more than one occasion that “cushion” has been the difference between catching a flight or not. Planning that only considers a “best” or “normal” scenario too often overlooks the unexpected—and sometimes that margin of error is all you have.

For over a decade EBRI has modeled the nation’s potential retirement savings shortfall, and the EBRI Retirement Readiness Ratings™ provide an assessment of how many Americans are at risk of running short of money for needed expenses in retirement. In contemplating expenses, that model considers the regular expenses of living in retirement, as well as uninsured medical expenses, and the potential costs of nursing home care.

However, we have also documented and quantified the role of Social Security, defined benefit and private retirement accounts on retirement income adequacy for Baby Boomers and Gen Xers with an eye toward replacing their preretirement wages and income. While this more traditional focus on income replacement may misstate an individual’s actual post-retirement financial situation, many financial planners work with this goal as a starting point, and it can provide valuable insights particularly when—as is the case with EBRI’s projections—it is able to leverage actual 401(k) data from the unique EBRI/ICI 401(k) database, the largest such repository in the world.

Indeed, based on a recent EBRI analysis, between 83 and 86 percent of workers with more than 30 years of eligibility in a voluntary enrollment 401(k) plan are simulated to have sufficient 401(k) accumulations that, combined with current levels of Social Security retirement benefits, will be able to replace at least 60 percent of their age-64 wages and salary on an inflation-adjusted basis.

When the threshold for a financially successful retirement is increased to 70 percent replacement of age-64 income, 73–76 percent of these workers will still meet that threshold, relying only on 401(k) and Social Security combined. At an 80 percent replacement rate, 67 percent of the lowest-income quartile will still meet the threshold; however the percentage of those in the highest-income quartile deemed to be “successful” relying on just these two retirement components slips to 59 percent, reflecting the progressive nature of Social Security.

As positive a result as that seems for many, when the same analysis is conducted for automatic enrollment 401(k) plans (with an annual 1 percent automatic escalation provision and empirically derived opt-outs), the probability of success increases substantially: 88–94 percent at a 60 percent threshold; 81–90 percent at a 70 percent replacement threshold; and 73–85 percent at an 80 percent threshold.

That’s not quite the doomsday crisis scenario portrayed by many of the headlines in vogue today, though EBRI’s projections still show that a large number of Americans—even among those eligible for a 401(k) plan for 30 years—won’t be able to replace that pre-65 salary even at the various levels modeled, based on current savings patterns.

It does, however, illustrate the impact that changes in those current savings behaviors can have—and it underscores the significant role of Social Security as a vital safety net for the nation’s retirement security.

Nevin E. Adams, JD

“The Role of Social Security, Defined Benefits, and Private Retirement Accounts in the Face of the Retirement Crisis” is available online here.

"Whether" Forecasts

This is the time of year where, in many parts of the county, the weather—and weather forecasters—dominate the nightly news coverage, certainly when the predictions are dire.  Indeed, having had the opportunity to live in several different parts of the country, I can assure you that the bigger the projected snowfall, the more hyped the coverage.

Several weeks back, the local meteorologists were all agog about an impending snowfall in the Washington, DC area—a snowfall  initially projected at 2–4 inches of accumulation, but that was quickly revised to 3–5 inches, and then to 4–7 inches.  The local mass transportation systems sprang into action, announcing alternative schedules, state officials advised those who didn’t need to be on the roads to stay home, non-emergency federal employees in the area were granted an excused absence, while others were directed to telecommute.

As it turned out, it did snow—but not much, and certainly not in the amounts that had garnered all the attention.  Afterwards, meteorologists were quick to point out that accumulations had matched projections in some areas, although those areas were relatively small and generally far removed from major metropolitan centers.  Ultimately, more were affected by the weather forecast than the weather itself.

Dire predictions are also common about the retirement prospects for Americans.  A recent headline proclaims “Americans Are $6.8 Trillion Short On Retirement Savings,” a figure that the article proceeds to tell us amounts to $113,000 per household “for those on the eve of retirement” —that is, those ages 55 to 64.

Actually, that $6.8 trillion is the low end of a range published by the National Institute on Retirement Security (NIRS) about six months ago,[1] and is close to the $6.6 trillion estimate of the Center for Retirement Research (CRR), which we have commented on previously (see “Rely-Able?”)  The NIRS projections were largely derived by looking at self-reported retirement account balances, financial assets and net worth from the Federal Reserve’s 2010 Survey of Consumer Finances, incorporating some assumptions about defined benefit assets, and extrapolating target retirement savings needs based on a set of age-based income multipliers—income multipliers, it should be noted, that have no apparent connection with actual income, or with actual spending needs in retirement.

For public policy purposes, EBRI has long defined adequate retirement income as having the financial resources to cover basic expenses plus uninsured medical costs in retirement. Working from that definition as a starting point, along with an assumption that retirement represents the cessation of paid employment and begins at age 65[2], we have projected that approximately 44 percent of Baby Boomer and Gen-Xer households are simulated to be at risk of running short of money in retirement, assuming they retain any net housing equity until other financial resources are depleted.  Our most recent assessment of that total aggregate gap between needs and available resources is $4.6 trillion, with an individual average of approximately $48,000.[3]

That is, of course, still a large gap, though one considerably smaller than that highlighted in the article.  While it represents a lot of households—it also includes a wide range of personal circumstances, from individuals projected to run short by as little as a dollar to those projected to fall short by tens of thousands of dollars.[4]  For those seeking to understand, and perhaps craft solutions for, the current projected shortfalls, this is an important distinction, and one given short shrift by a headline’s focus on the aggregate.

A lot of science goes into making weather projections, and yet a temperature difference of a mere degree or two can be the difference between a modest rainfall or a blizzard of epic proportion.  Beyond those reality variables, imprecise modeling assumptions can distort forecasts, producing their own disruptions.

When it comes to effective retirement policy, it is, of course, important to be able to quantify just how big the nation’s retirement savings shortfall is.  It is, however, perhaps even more important to remember that whether an individual shortfall exists will be a combination of individual circumstances, as well as varying degrees of preparation, access, and needs.

Nevin E. Adams, JD

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[1] The NIRS report, “The Retirement Savings Crisis: Is it Worse than We Think?” is available online here.

[2] EBRI has also performed analysis on retirement ages other than 65. 

[3] EBRI recently submitted congressional testimony on “The Role of Social Security, Defined Benefits, and Private Retirement Accounts in the Face of the Retirement Crisis.”  Included in that testimony was an analysis of the probabilities of successful retirement by income quartile for both voluntary and automatic enrollment 401(k) plans.   You can read it online here.   

[4] Nearly one-half (49.1 percent) of Gen Xers are projected to have at least 20 percent more than is simulated to be needed, for example, while about 1 in 5 (19.4 percent) are projected to have less than 80 percent of what is needed. See “All or Nothing? An Expanded Perspective on Retirement Readiness,” online here. 

Rates of "Return"

Having just concluded a long driving trip, I was reminded again just how helpful the technology under the hood of today’s automobiles can be: the warning lights when you’ve still got enough gas left to find a gas station, the low tire pressure light that tells you of a slow leak before you have a flat tire, the binging that lets you know you’ve left your headlights on (again), and my personal favorite, the klaxon-like bell that alerts you that your parking brake is still engaged (since that red “brake” light on the dashboard clearly wasn’t sufficient notice).

Before such warning signs were standard features, I’ve had the decidedly unpleasant experience of running out of gas in the middle of nowhere, finding myself driving on (two) flat tires, and—many years ago—I’m pretty sure I was responsible for ruining the brakes on my Dad’s car simply because I didn’t realize that the smell of burning rubber was coming from the car I was driving.

For some time now, the Federal Reserve has held short-term interest rates near zero in an effort to support an economic recovery—and has, in fact, announced its intention to maintain that policy until such time as the recovery seems to have taken hold. However, as many retirees and workers have discovered, those historically low interest rates are crimping their retirement savings—and a new study by the Employee Benefit Research Institute (EBR)¹ quantifies the impact of a sustained low-interest rate environment on America’s retirement readiness.

Using EBRI’s unique Retirement Security Projection Model® (RSPM), we found that more than a quarter of Baby Boomers and Gen Xers who would have had adequate retirement income under an assumption that historical average market returns would prevail are instead simulated to end up running short of money in retirement if today’s historically low interest rates are assumed to be a permanent condition (assuming retirement income/wealth is assumed to cover 100 percent of simulated retirement expense²).

Not that everyone is affected to the same degree. In fact, the analysis reveals that the potential impact varies by income levels: The low-yield-rate environment appears to have a limited impact on retirement income adequacy for those in the lowest preretirement income quartile, since they have relatively small levels of defined contribution and IRA assets and since they rely more heavily on Social Security income in retirement. However, the research found there is a very significant impact for the top three income quartiles.³

The research found that the impact is lessened if the current low rates are temporary, but that its impact can be magnified by years of future eligibility for participation in a defined contribution plan. For example, moving from the historical-return assumption to a zero-real-interest-rate assumption results in an 11 percentage-point decrease in simulated retirement readiness for Gen Xers who have one to nine years of future eligibility, but that gap widens to a 15 percentage-point decrease in retirement readiness for those with 10 or more years of future eligibility.

In recent days, word that the Federal Reserve sees an end to its current policies has brought some volatility to the stock market. While several sectors of the economy have benefitted from the U.S. Federal Reserve holding short-term interest rates near zero to support a recovery, there are warning signs in the EBRI analysis about longer-term consequences that policy makers should also consider—and implications for retirement readiness should historical averages return.

Nevin E. Adams, JD

¹ The full report is published in the June 2013 EBRI Notes, “What a Sustained Low-yield Rate Environment Means for Retirement Income Adequacy: Results From the 2013 EBRI Retirement Security Projection Model,®” online here.

² When 80 percent of simulated retirement expenses must be covered, only 5‒8 percent are simulated to run short of money.

³ This is in sharp contrast to a recent report by the Center for Retirement Research at Boston College that claimed that the lower interest rates had only a minor impact for ALL income categories. However, as we have noted previously, CRR’s National Retirement Risk Index, on which the conclusions are based, continues to assume that all retirees annuitize all of their defined contribution and IRA balances; continues to ignore the impact of long-term care and nursing home costs or assumes that they are insured against by everyone; and also seems to rely on an outdated perspective of 401(k)-plan designs and savings trends, essentially ignoring the impact of automatic enrollment, auto-escalation of contributions, and the diversification impact of qualified default investment alternatives. Additionally, given the way their model assumes assets accumulate during the preretirement period, the change in interest rates has NO impact on accumulations at retirement age. See “Rely Able?”