In the realm of things that need to be vetted is the case of how much retirement savings one really needs to have in order to live close to the lifestyle one habituated during his or her working years.
Retirement savings investors, who have a rock-solid interest in making sure savers dump lots of dollars into their accounts, seem to be inflating the amount of money people need to have to live comfortably, says Andrew Biggs, a former Social Security Administration deputy commissioner and associate director of the White House National Economic Council.
Biggs has been on a tear lately, looking at different analyses, including one from Bankrate.com and another from Aon-Hewitt, both firms that would benefit from individuals socking away higher savings. He suggests that the retirement savings “crisis” is part hysteria and part bad math.
Bankrate found that retirees had average incomes equal to just 60% of working-age households, 10 percentage points short of the 70% ‘replacement rate’ that most financial advisors recommend. In only three states – Hawaii, Alaska and South Carolina – did Bankrate find that average retirement incomes topped 70% of pre-retirement incomes.
So are things really that bad for today’s retirees? Not at all. In fact, if we recreate Bankrate’s analysis while correcting for several important errors, today’s retirees don’t merely meet the 70% ‘replacement rate’ target – they actually have average incomes that match those of households who are in their peak earning years.
How does Biggs reach his conclusion? Being an economist, he starts by comparing apples to apples. For one, he corrects for the fact that the Census Bureau’s American Community Survey, which Bankrate used to measure retiree incomes, doesn’t count IRAs and 401(k) earnings as “income” because the money doesn’t show up as a regular check in the mail. That means the drawdowns off those accounts are not counted as income in Bankrate’s analysis despite the fact that the money is the equivalent of income to finance retiree households.
Then Biggs adjusts for the fact that Bankrate averages per capita income in households based on an average of 2.3 people in the home, which is the average number of people in households not at retirement age, but in the 20 years before retirement. In households over 65, the average number of people is 1.7, which means the per capita average immediately goes up.
Lastly, Biggs notes that since incomes rise over time — on average 27 percent over the last 21 years — trying to compare incomes of retirees to incomes of working-age households is misleading because retirees have determined their retirement needs based on what they earned while they were working, not on what workers are earning today.
So what does this all mean?
If we want to accurately measure retirees’ incomes we need to accurately capture IRA and 401(k) withdrawals. That points toward IRS Statistics of Income data, since those withdrawals are taxable and thus are more fully reported. For households aged 65 and over in 2013, IRS data show an average total income of $70,085. Divide that by 1.7 individuals per household and you get per capita income of $41,227. Those same IRS data show an average income of $88,670 for households aged 45 to 64. Divide that by an average household size of 2.3 and you get per capita income of $38,552. While the IRS data have some shortcomings, which I’ll discuss below, these figures don’t look anything like the 60% “replacement rate” the Bankrate analysis produced. Indeed, today’s retirees have incomes that are very similar to Americans who are in the prime of their working lives. And that’s before accounting for the increase in salaries from the time today’s retirees were in their prime working years.
Biggs notes that the IRS data have flaws, most notably the lack of a historical data trail before 2006, the use of averages rather than medians, which measure the true middle point between high and low incomes, and the fact that low-income households don’t file returns.
But still, you get the point: Fully counting the incomes received by today’s retirees – especially, withdrawals from retirement plans – shows that, on average, retirees are doing very well. No one argues that retirees need per capita incomes as high as households 20 years younger who are at the peaks of their working careers. But according to the IRS data, that’s what they have.
Does that mean all retirees are doing fine? Of course not, nor are all working-age households doing well. But if we’re looking at averages – and averages do tell us something meaningful – then today’s retirees are doing pretty darn well.
In a separate piece, Biggs takes down Aon-Hewitt’s claim that women need savings equal to 11.5 times their final pay while men need 10.6 times their final pay in accumulated wealth. Aon Hewitt laments that women are only on track to save 8.2 times their final pay while men are projected to have 8.6 times.
Biggs then looks at the quintiles established by the Social Security Administration to evaluate how well people fare in their final year of earning pay before retirement.
The SSA’s hypothetical earners are built on administrative data from Americans’ earnings and are classified as:
-
Very low: final earnings at age 65 of about $8,095 per year. About 19% of workers have earnings similar to the very low earner;
-
Low: final earnings of about $14,562 per year. About 22.5% of workers have earnings similar to the low earner;
-
Medium:final earnings of about $32,370 per year. About 29.8% of workers have earnings similar to the medium earner;
-
High: final earnings of about $51,732 per year. About 20.1% of workers have earnings similar to the high earner; and
-
Maximum, earning the maximum earning taxable by Social Security – currently $117,500 – every year of their working career. About 8.5% of workers have earnings similar to the maximum earner.
Biggs revisits the 70 percent replacement rate number as adequate income for a retiree as compared to a working-age person before adding a few assumptions about when people retire and how long they live.
He then notes:
The specifics of the recommendations don’t matter much here, though, because anyone saving for retirement using Aon-Hewitt’s rule of thumb would knock any recommended replacement rate right out of the park. For instance, a ‘medium’ earner earns about $32,370 just prior to retirement, though more than that – about $40,000 – in the peak earnings years of her mid-50s. She would receive a Social Security benefit of $21,354 per year plus an annual payment from her retirement savings of $20,011. Add it together and she has a total annual retirement income of $41,465, which is equal to 123% of her final earnings. If she were a very low-wage worker – which describes about 17% of female workers, according to the SSA – her total replacement rate would be 174%. Even if she earned the maximum taxable wage, currently $117,500, every year of her working career, under Aon’s retirement saving rule of thumb she would have a replacement rate of 89%, which is well above what financial planners recommend for high earners.
What’s troubling is why retirement savings investors are coming up with these numbers, and it’s ponderous to conclude with an answer, but it is worrisome that retirees appear to be enjoying a more comfortable standard of living than working-age households, according to Gallup and the Health and Retirement Study, which notes that 80 percent of retirees say their life is as good or better than before they retired.
You can read Biggs’ retirement income measurements at Forbes magazine as well as his article on how much retirement income people should plan to have.
