Half of Households Risk Inadequate Retirement Income

The average household must put away 15% of income toward retirement, a figure that falls dramatically through delayed retirement or an earlier start to saving

The average household needs to save 15% a year for retirement. The average household needs to save 15% a year for retirement.

A national survey of retirement readiness shows a steady and alarming rise in the proportion of Americans inadequately prepared for retirement.

Indeed, the National Retirement Risk Index (NRRI), calculated over the past three decades by the Center for Retirement Research (CRR) at Boston College, now finds — for the first time — that a majority of working age U.S. households are on track to experience a shortfall in replacement income.

This deficiency, defined as income replacement rates more than 10% below pre-retirement income, has risen steadily from 31% of households in the NRRI baseline survey of 1983.

The percentage of households off track for retirement income adequacy rose to near 40% in the 1990s, to the mid-40s a decade ago and reached 53% in 2010, the last complete year for which all pertinent data on income, pensions and housing were analyzed.

A new study by CRR’s Alicia Munnell, Anthony Webb and Wenliang Hou based on these findings seeks to determine how much working-age households need to save to make up for this shortfall.

The answer varies based on income group, but is 15% of income for the typical household.

The figure is derived by investigating the savings rate required to achieve income replacement minus the amount of income households can rely on from their various retirement savings plans.

In projecting income replacement rates, the analysts look at financial assets, investment returns and housing, as well as average lifetime income, minus debt.

Assuming a household’s goal is to achieve income matching their consumption immediately prior to retirement, they estimate post-retirement income by factoring in Social Security, employer pensions and an inflation-indexed annuity, purchased with the household’s financial assets and the proceeds of a reverse mortgage.

(The authors acknowledge that these annuities are not commonly purchased, but use it as a convenient metric for attainable lifetime income.)

In calculating needed savings rates in retirement plans, the analysts come up with varying targets based on household income, with lower income households needing to save less than higher income households. That is because Social Security’s progressive structure replaces more income for lower earners.

The study finds that “a quarter of retirement income must come from retirement savings plans — that is, pensions, 401(k)s and IRAs — for low-income housholds, one third for the middle income, and half for the high income.”

To achieve that level of retirement plan assets, the average household must save 15% of income, with low-income and high-income households need to saving 11% and 16% of income, respectively.

However, because a majority of households have not saved enough, they must increase their savings in order to catch up, and that increased amount depends crucially on age.

Households in their 30s need only increase their savings rate by a manageable 7% for the typical household, by 13% for savers in their 40s, but by an “unrealistic” 29% for people in their 50s.

For that reason, the study suggests that extending their working years is a more realistic way for older households to make up that shortfall.

For illustration, the report’s authors say that an average couple planning to retire at 65 in 2040, who can expect Social Security to replace 36% of their income, need to accumulate $538,000 in their working years.

By starting saving at age 35 and earning a real return of 4% on their investments, they will need to put away 15% of their income annually to meet their goal.

“However, if they delay retirement to 70, that figure drops from 15% to 6%," the authors advise. "Starting to save earlier would bring the rate even lower.” 

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