Children’s Tale – Early Steps for Retirement Planning
Stephen P. Gallagher
I recently looked into retirement accounts – 401(k)s and IRAs – and how they are playing an increasingly important role in the nation’s retirement system for two reasons. First, Social Security, the backbone of the system, will provide less relative to pre-retirement earnings in the future than in the past, so people will need more from their employer-sponsored plans. Second, among employer-sponsored plans the structure has shifted from traditional defined benefit plans (DB), which pay lifetime benefits, to 401(k)s and IRAs, where balances determine retirement resources.
I used The Research Contributions of the Center for Retirement Research at Boston College by Steven A. Sass (Social Security Bulletin, Vol. 69, No. 4, 2009). I am reporting on this research for my children.
Unfortunately, only about half of private sector workers – at any moment in time – are offered either a defined benefit or a defined contribution plan. This share is lower today than it was 35 years ago. So, my first suggestion is to find an employer who offers a 401 (k) program and maximize your contributions.
The Center for Retirement Research (CRR) at Boston College was established in October 1998 as part of the Social Security Administration’s (SSA’s) Retirement Research Consortium (RRC). The CRR has produced literature that synthesize current research on key Social Security and retirement income policy issues. The research output of the CRR and its affiliates, organized by topic, is listed at http://crr.bc.edu.
Let me start with what I see as important facts from the report. According to a 2009 projection of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Fund (2009), benefit outlays will exhaust the Social Security trust fund in 2037.
Steven Sass and his team report that, today we live in the “golden age of retirement.” The expansion of Social Security and employer pension plans, the creation of Medicare, and the rise in home ownership over the past half century have allowed most retirees to maintain a reasonable approximation of the standard of living they enjoyed during their working years. Engen, Gale, and Uccello (2000) find only 20 percent of households in the initial Health and Retirement Study (HRS) cohort (individuals born from 1921 through 1931) at risk of hardship. Despite some areas of weakness, the report goes on to say that the overall economic standing of the elderly, compared with the young, has likely never been better.
An important question in this report is how well retirement incomes will hold up when the baby boom generation exits the workforce. As Social Security is the largest source of cash income for two-thirds of elderly households, SSA’s calculation of monthly benefits paid to the “medium earner,” as a share of pre-retirement earnings, is a common measure for assessing retirement income adequacy. Through the last quarter of the twentieth century, the benefits of a medium earner—essentially an individual who consistently earns the average wage and retires at age 65—generally replaced about 40 percent of pre-retirement earnings. But as most workers retire as married couples and claim benefits before age 65, this figure might not be a reliable indicator of the program’s role in replacing pre-retirement earnings. (page 38)
The 401(k) system has evolved over time into a collection mechanism for retirement saving; the bulk of the money now resides in IRAs. The 2016 Survey of Consumer Finances offers the first glimpse of the current level of household combined 401(k)/IRA holdings. The typical household approaching retirement had $135,000 in combined 401(k)/IRA assets. These assets will provide $600 per month in retirement, an amount whose purchasing power will decline over time with inflation. Moreover, only half of households have any 401(k)-related holdings
Employer-Sponsored Retirement Income Plans
Employer-sponsored retirement income plans that are publicly subsidized and regulated are the second most important source of retirement income, providing about 20 percent of elderly household cash income if wages are included as a source of income; without wages, these plans provide about 25 percent of elderly household retirement income. Participation has remained remarkably constant over the past quarter century, at about half the nation’s workforce, suggesting the continued importance of employer plans going forward.
Much of the Center for Retirement Research’s work on employer plans has focused on the new Defined Contribution (DC) programs. In Coming Up Short: The Challenge of 401(k)Plans, Munnell and Sundén (2004) synthesize much of their research, as well as research done by others, to produce an overall evaluation of such plans as a source of retirement income. As the title makes clear, the authors find significant limitations in the ability of 401(k) plans to function as a reliable source of retirement income.
Studies by Bosworth, Bryant, and Burtless (2004) and Engelhardt and Kumar (2007a) on the effect of demographic swings on saving and investment demand also suggest that it will become more difficult to accumulate retirement wealth while working and to rely on such wealth to provide an income in retirement, as the baby boom generation exits the labor force.
National Retirement Risk Index
To gauge the extent of the retirement income problem going forward, the Center for Retirement Research at Boston College (2006) developed a National Retirement Risk Index. This index estimates the share of working-age households “at risk” of lacking sufficient retirement income to maintain a reasonable approximation of their pre-retirement standard of living, that is, households with projected retirement incomes at 10 percent or more below the estimated amount needed to maintain pre-retirement living standards. Depending on factors such as household composition, home ownership, and the level of pre-retirement income, households are classified as at risk if their projected retirement income is less than about 65 percent of their income in their fifties.
The retirement income calculation assumes the household head retires at age 65, not the current average retirement age of 63, and the household annuitizes all assets, including the value of home equity not consumed over the household’s remaining life, leaving no intended or unintended bequest. Driven by scheduled declines in Social Security replacement rates (the retirement income estimates do not include additional benefit cuts to close the long-term shortfall) and projected declines in replacement income provided by employer plans and other types of saving and rising longevity, the study finds a steady rise in the share of households at risk—35 percent of older boomers (born from 1948 through 1954), 44 percent of younger boomers (born from 1955 through 1964), and 49 percent of “Generation X” (born from 1965 through 1972)—that could well mark the end of the “golden age of retirement.”
Projections of the well-being of future retirees, such as the CRR’s National Retirement Risk Index, generally assume retirees will consume much or all of this wealth, either through annuitization or by adopting some optimal drawdown strategy based on survival probabilities and household time and risk preferences. Retirees today, however, are quite resistant to annuitizing financial assets or tapping home equity as a source of retirement income through downsizing, borrowing, or taking out a reverse mortgage. To the extent that future retirees fail to convert financial and housing wealth into retirement income, their standard of living will be less than generally projected.
Although Munnell and Soto (2008) find that about 30 percent of households aged 50–62 had increased mortgage debt in response to the rapid run-up in housing prices earlier in the decade, home equity is by far the largest untapped asset available as a source of retirement income for most households in or near retirement. The elderly, however, rarely convert housing wealth into cash income. Munnell, Soto, and Aubry (2007) report the results of a survey that finds that few households approaching retirement plan to tap their home equity for retirement, but those inadequately prepared for retirement and dependent on DC plans as opposed to DB plans are more disposed to do so.
As retirees increasingly find themselves ill-prepared and dependent on DC plans, home equity could thus become a far more important source of retirement income.
Given the decline in replacement income provided by Social Security and employer pension plans, the limited extent of other savings, and the pattern of resistance to annuitization or tapping home equity as a source of retirement income, the only alternative to sharply lower living standards for many retirees is to remain in the labor force longer.
Munnell and Sass (2008) synthesized much of the research on the prospects for extending working careers in Working Longer: A Solution to the Retirement Income Challenge. As reported in Working Longer, health is not a major obstacle in extending careers. A review of the evidence, also reported in Munnell and Libby (2007), indicates that individuals aged 55–64 today are healthier than their counterparts in 1960 and that work has become less physically demanding, though perhaps 15–20 percent of workers would not be able to remain in the labor force into their mid-to-late sixties. For those who can work at these ages, Calvo (2006) finds that work actually enhances health and happiness. So, the critical questions are whether workers will choose to extend their careers and whether employers will choose to employ them.
Using age and tenure data from the Current Population Survey, Munnell and Sass (2008) report that only 44 percent of employed men aged 58–62 currently work full time for the same employer they had at age 50, a dramatic change from the early 1980s when 70 percent of men in that age range were working full time for their age-50 employer. For workers in their fifties, job transitions are often quite difficult. Lahey (2006) documents significant age discrimination in the job search, using interview request rates responding to paired résumés submitted by applicants for entry-level jobs, with information on the résumés addressing concerns over issues such as job skills and the need for health insurance.
Center on Retirement Research Report Conclusion
The Center of Retirement Research’s review of the 401(k) institution, In Coming Up Short: The Challenge of 401(k)Plans, helped make the case that reform was needed—that 401(k) plans as currently structured would not produce enough retirement income for workers dependent on these programs. The CRR also helped open critical new areas of retirement policy research. Perhaps most important is the employment of older workers, increasingly viewed as the nation’s most effective response to shortcomings in the retirement income system. Given the nation’s pressing retirement income challenges, the CRR’s contributions to the policy debate have arrived none too early.
Bosworth, Barry P., Ralph C. Bryant, and Gary Burtless. 2004. The impact of aging on financial markets and the economy: A survey. CRR Working Paper 2004-23.Chestnut Hill, MA: Center for Retirement Research at Boston College.
Butrica, Barbara A., Howard M. Iams, and Karen E. Smith. 2003. It’s all relative: Understanding the retirement prospects of baby-boomers. CRR Working Paper 2003-21. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Calvo, Esteban. 2006. Does working longer make people healthier and happier? Work Opportunities Brief 2. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Cox, Donald, and Beth J. Soldo. 2004. Motivation for money and care that adult children provide for parents: Evidence from “point-blank” survey questions. CRRWorking Paper 2004-17. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Engen, Eric M., William G. Gale, and Cori Uccello. 2000. The adequacy of household saving. CRR Working Paper 2000-1. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Engelhardt, Gary V., and Anil Kumar. 2007a. Saving and demographic change: The global dimension. CRR Working Paper 2007-2. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Lahey, Joanna. 2006. State age protection laws and age discrimination in employment act. CRR Working Paper 2006-24. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Munnell, Alicia H., and Jerilyn Libby. 2007. Will people be healthy enough to work longer? Issue in Brief 7-3. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Munnell, Alicia H., and Steven A. Sass. 2008. Working longer: The solution to the retirement income challenge. Washington, DC: Brookings Institution Press.
Munnell, Alicia H., Mauricio Soto, and Jean-Pierre Aubry. 2007. Do people plan to tap their home equity in retirement? Issue in Brief 7-7. Chestnut Hill, MA: Center for Retirement Research at Boston College.
Munnell, Alicia H., Mauricio Soto, and Natalia A. Zhivan. 2008. Why do more older men work in some states? Issue in Brief 8-6. Chestnut Hill, MA: Center for Retirement
 The 2037 exhaustion date refers to the Old-Age and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund combined.
 Munnell, Alicia H, and Anqi Chen (2017), 401(K) /IRA Holding in 2016: An Update from the SCF, p. 8
 Munnell and Soto (2005a) and Social Security Administration (2006).
 Also see Butrica, Iams, and Smith (2003)—”It’s All Relative: Understanding the Retirement Prospects of Baby-Boomers”—which highlights the importance of the standard of reference, whether the adequacy of retirement incomes is measured relative to workers’ preretirement standard of living or some other standard, such as the standard of living of current retirees.
 Without annuitization, households pursuing “optimal” drawdown strategies would consume more of their incomes when relatively young and have incomes declining rather steeply over time, with “unlucky,” long-lived households having no income at the end of their lives other than their Social Security benefits. This consumption pattern is inferior to that offered by an actuarially fair annuity, given reasonable assumptions and abstracting from bequest and precautionary wealth-holding motives.
 Inheritances, most often the value of the parents’ house, are sometimes seen as an important retirement asset. But such bequests have not been major contributors to the income of most retirees and are unlikely to be so in the future. Cox and Soldo (2004), however, do show that the promise of a bequest is sometimes explicitly or implicitly exchanged for caregiving.
 Lahey (2006) also finds evidence that more vigorous antidiscrimination efforts could be counterproductive. As states with tougher regimes have lower employment rates for older workers, employers seem to respond by avoiding hiring or retaining older workers.