Can America afford to retire? As millions of baby boomers pass their mid-60s, the specter of widespread under-saving has taken hold. Huge numbers of present and future retirees will exhaust their savings before they die. Mass hardship looms, even as the costs of an aging society already weigh on the young and middle-aged. It’s a scary vision. But is it likely? Probably not.
Typical retirees are hardly bereft. In 2010, roughly 80 percent of households headed by someone 65 to 74 owned their homes, and half of these had fully repaid their mortgages, reports economist Peter Brady of the Investment Company Institute, the trade group for mutual funds. Among those with a mortgage, the median amount was less than half (44 percent) of the house’s value. For all homeowners, median home equity — the amount not owed on the mortgage — was $120,000. (The median signifies the midpoint. Amounts were higher for half the households, lower for the other half.)
To supplement Social Security, retirees can borrow against their home equity. They can also draw on retiree savings from defined benefit pensions, individual retirement accounts (IRAs) and 401(k) accounts. In 2010, almost three-quarters of households aged 55 to 64 had some combination of these retirement vehicles. The median value of the IRA and 401(k) accounts was $100,000, Brady says.
Retirees, it’s often said, have to achieve a “replacement rate” of 80 percent of their former income to match pre-retirement living standards. Just where this figure came from isn’t clear. Brady found a reference as early as 1980 in an interim report of the President’s Commission on Pension Policy. Whatever its origin, the target is misleading. It’s disconnected from financial realities.
Think of all the expenses that retirees escape. Not working, they don’t pay Social Security and Medicare payroll taxes, totaling 7.65 percent of wages. Gone are other work expenses: commuting, parking, clothes and (possibly) lunches out. Children should have left home, reducing costs for their food, school and dress. Even if some have returned, expenses should be less. If the mortgage is repaid, retirees effectively live in their homes rent-free. Similarly, their saving should be over. For many, this equals 10 percent or more of income. Granted, some stiff costs remain: out-of-pocket medical costs, utility bills and property taxes.
A realistic replacement rate, though hard to measure, is well below 80 percent. As important, the concept’s usefulness is limited. Matching pre-retirement living standards can be desirable, but it’s not a proper public-policy goal. How well people live in retirement depends mostly on how productively and prudently they lived before retirement. It’s a matter of personal responsibility. Public policy should aim more modestly at protecting against hardship.
The Investment Company Institute recently held a conference on the adequacy of retirement savings. Studies vary widely. The Center for Retirement Research at Boston College estimates that half of Americans aren’t saving enough. By contrast, economists John Karl Scholz and Ananth Seshadri of the University of Wisconsin put under-savers at only 10 percent to 15 percent. The big difference: The Boston College figure assumes retirees’ spending (a.k.a., the replacement rate) remains constant throughout retirement; the Wisconsin economists think people gradually reduce spending as they grow older and are less active. Lower retirement spending requires less pre-retirement saving.
Studies aside, there’s little real-world evidence of pervasive under-saving. Older Americans feel better about their finances than any other age group, report surveys by NORC at the University of Chicago. In 2012, 80 percent of those 65 and over were “satisfied” or “more or less satisfied” with their financial situation compared with only 67 percent of those aged 50 to 64. Other age groups also lagged; comparable results date to the 1970s.
Of course, there are serious social problems here. One is that most of the poor don’t save. The poorest quarter of the elderly rely on Social Security for 85 percent of their income, notes economist James Poterba of the Massachusetts Institute of Technology. Another problem: People don’t know when they’ll die. It’s difficult to plan. People who live longer than expected or who spend extended stretches in a nursing home can exhaust sizable savings. Without nursing-home costs, about 90 percent of baby-boom retirees will have adequate incomes, estimates Jack VanDerhei of the Employee Benefit Research Institute. With nursing homes, that drops to about 80 percent.
More Americans are trying to ease the uncertainties by working longer. Labor force participation has increased for 60-somethings, Poterba points out. This creates more years of saving and fewer of post-retirement spending. Raising Social Security’s eligibility ages would also be smart. As life expectancy lengthens, it makes less sense for so many people to spend so many years living off their savings and subsidies from the young and middle-aged. Retirement would be more secure if it were shorter.
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