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Issues 2020: Are Americans Prepared for Retirement?

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issue brief

Issues 2020: Are Americans Prepared for Retirement?

September 29, 2020
EconomicsRegulations

The Narrative

"At a time when about half of American households over the age of 55 have no retirement savings and one out of five seniors are trying to live on less than $13,500 a year, our job is not to cut Social Security. Our job is to expand Social Security so that everyone in this country can retire with the dignity they have earned and everyone with a disability can live with the security they need."[1]
— Bernie Sanders

 

"Americans are reaching retirement age in worse financial shape than the prior generation, for the first time since Harry Truman was president.... In total, more than 40% of households headed by people aged 55 through 70 lack sufficient resources to maintain their living standard in retirement."[2]
Wall Street Journal

 

"We need to expand Social Security and provide our seniors and other beneficiaries of this vital program with greater dignity and peace of mind."[3]
— Kamala Harris

Reality

Americans have never been better prepared for retirement. In the past, employer-provided defined benefit pensions may have provided a secure income to the minority of Americans who had them—but participation peaked at 39% of employees in 1973. Today, more than half of households participate in a retirement plan, most of them defined contribution plans like a 401(k).

As the first generation to rely on defined contribution plans reaches retirement, they have more retirement income than previous generations, and elderly poverty stands at an all-time low. There is no need to expand Social Security, which is already responsible for a large share of projected future deficits. Social Security was never meant to be the sole source of Americans’ retirement income, and it is not desirable or efficient to make it one.


Key Findings

While defined benefit plans were never accessible to most Americans, defined contribution plans, such as a 401(k), have made most Americans better off.

  • The golden days of defined benefit pensions were never so golden; fewer than 40% of Americans participated in one. Today, more than 53% of Americans have some form of retirement plan.
  • The median balance among 61–69-year-olds with defined contribution plans is $150,000.
  • Only about 20% of Americans rely exclusively on Social Security; most of them were low-income earners who get a high replacement rate because of the program’s progressive benefit formula.

As the first generation with defined contribution plans retires, they are enjoying higher retirement incomes than previous generations, and most aren’t struggling.

  • The retirement income of 70-year-olds, across the income distribution, has increased since 2000.[4]
  • The poverty rate of the elderly is close to historical lows.[5]
  • The value of Social Security benefits has increased over time.

The value of defined benefit pensions can be overstated.

  • It is true that the income from defined benefit plans can be more generous than defined contribution plans—but defined benefit plans are not so valuable if you change jobs.
  • Even higher-earning Americans, who tended to have defined benefit plans in the past, have more retirement income than before.

On the Record

"Most retirees have more income than previous generations, and if past retirees had good retirements, so will current and future retirees. Having the government provide enough risk-free income to finance most Americans’ entire retirement is extremely expensive, unnecessary, and implausible in the current fiscal environment."

—Allison Schrager, senior fellow, Manhattan Institute

The Average Retiree Has More than Ever

There was never a golden age of retirement in the United States. Social Security did expand in the postwar era to include most workers in the private sector, and some employers, in addition, offered generous pensions to their workers. But most workers did not have these private pensions: at their peak in 1970, only 39% of Americans participated in a defined benefit (DB) plan, and these were typically higher earners.[6]

Defined contribution (DC) plans like 401(k)s are not as generous as DBs, but more employers can offer them to more workers. More than half of Americans now have some form of a retirement plan,[7] and among 61–69-year-olds who have a DC plan, the median balance is about $150,000, which buys about $7,500 a year in inflation-protected income.[8]

Moreover, DB pensions are less valuable than they once were. Getting a significant DB benefit requires long tenure at a single firm, but long tenure has become less common.[9] DC pensions enable workers to change jobs without penalty. This tends to increase earnings, and that means more money to save for retirement.

Thus, it is not surprising that the first generation to retire after a career where DC plans were popular—who began to enter retirement in large numbers in about 2010—are doing better than any previous generation. Economists who compared Social Security and IRS records for retirees in 2000 and 2016 found that access to some form of retirement benefit has been flat or increased, and the amount of income that typical retirees receive from their employer-sponsored retirement benefit did not decrease. The economists found no evidence that the decline of DB pensions resulted in less retirement income for the average household.[10]

Looking across all sources of income (including Social Security, retirement plans, and other forms of savings), most retirees are doing better than before. The research estimates that 70-year-olds in 2011 had more income than they did in 2000. This is true across the income spectrum. From 2000 to 2011, the median 70-year-old’s income increased from $30,710 to $33,908, while those at the 25th percentile saw an increase from $15,341 to $17,225, and those at the 75th percentile saw an increase from $51,360 to $56,522.

As retirees age, most continue to be better off than in the past. From 2010 to 2016, pretax income rose by 5.0% for the median 80-year-old, 8.4% at the 75th percentile, and 12.2% at the 90th percentile. Pretax income did fall by 0.8% at the 25th percentile and by 6.6% at the 10th percentile, but lower-income seniors are still less likely to be destitute than in the past. During the 1970s (often looked back on as a supposed golden era for retirement), the elderly were the group most likely to be poor; poverty rates among Americans older than 65 hovered around 30%. In 2018, the elderly had the lowest poverty rate: 9.7%. The poverty rate among the elderly has been at historical lows since the 2007–08 financial crisis.[11]

Social Security Benefits Are Already Generous

The vast majority of retirees do not rely mostly on Social Security. Only 19.2% of 70-year-olds and 24.2% of 80-year-olds do so.[12] The retirees who do rely on Social Security are mostly low-income households. Nevertheless, they get a very high replacement rate (the ratio of benefits to average working income) because the benefit formula for Social Security is progressive and based on lifetime income.

Further, all seniors, whether they rely primarily on Social Security or not, are receiving more generous Social Security benefits than in the past. This is because people live longer, so they receive benefits for more years, benefits are indexed to wages—which grow faster than prices—and the value of low-risk income has increased over the years, with falling interest rates.

Improving the Retirement System

Opportunities do exist to improve the process of saving for retirement and spending those savings in retirement. For instance, DC plans allow people to accumulate wealth but often leave them unsure of how to translate these savings into sustainable income. Many retirees end up not spending much of their savings until they get sick.[13] In some cases, this leads them to underspend. In other cases, they run out of money. And many struggle to manage the uncertainty of how to prepare for potentially high end-of-life costs or long-term care, for which the insurance market does not offer many viable options.

Policymakers have so far been unsuccessful in finding ways to address the costs of long-term care, so the burden often falls on Medicaid. One solution could include subsidies for the purchase of private, long-term-care insurance. Another might be tax incentives to encourage more annuity purchases, which would mean more income to pay for long-term care rather than relying on Medicaid. The challenges that remain for increasingly wealthy seniors have less to do with the type or generosity of their retirement plans than with their strategies for spending down their assets effectively.

But these narrow problems invite targeted solutions, not an enormous expansion of Social Security benefits for the entire population. Most retirees have more income than previous generations, and if past retirees had good retirements, so will current and future retirees. Having the government provide enough risk-free income to finance most Americans’ entire retirement is extremely expensive, unnecessary, and implausible in the current fiscal environment. Any resources we have available would be much better spent on the low-income elderly or improving options for long-term care.

Endnotes

  1. Bernie Sanders, “The Right to a Secure Retirement,” berniesanders.com.
  2. Heather Gillers, Anne Tergesen, and Leslie Scism, “A Generation of Americans Is Entering Old Age the Least Prepared in Decades,” Wall Street Journal, June 22, 2018.
  3. Kamala Harris, “Harris Joins Colleagues to Introduce Bill to Expand Social Security,” harris.senate.gov, Feb. 13, 2019.
  4. Trends in Retirement Income Adequacy,” NBER Bulletin on Retirement and Disability, Sept. 29, 2019.
  5. Jessica Semega et al., “Income and Poverty in the United States: 2018,” U.S. Census Bureau, Report no. P60-266, Sept. 10, 2019, fig. 11: Poverty Rates by Age: 1959 to 2018.
  6. Based on estimates from the Federal Reserve’s 2016 Survey of Consumer Finances, July 28, 2018, Americans in 1989 who earned between $100,000 and $250,000 were more likely to have a DB plan than Americans who earned between $50,000 and $100,000.
  7. Based on estimates from Federal Reserve, 2016 Survey of Consumer Finances, July 28, 2018.
  8. Based on estimates from the Federal Reserve’s 2016 Survey of Consumer Finances.
  9. Craig Copeland, “Trends in Employee Tenure, 1983–2018,” EBRI Issue Brief, Feb. 28, 2019.
  10. John Beshears et al., “Trends in Retirement Income Adequacy: Evidence from IRS Tax Data,” NBER Retirement and Disability Research Center Working Paper no. NB19-06, Sept. 29, 2019.
  11. U.S. Census Bureau, “Income and Poverty in the United States: 2018,” Sept. 10, 2019.
  12. Beshears, “Trends in Retirement Income Adequacy.” These numbers are up slightly over the past 20 years. In 2000, 18.2% of 70-year-olds and 22.9% of 80-year-olds were mostly dependent on Social Security.
  13. Jim Poterba et al., “The Drawdown of Personal Retirement Assets: Husbanding or Squandering?” NBER Working Paper no. 16675 (July 2013).

Photo by AlexRaths/iStock

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