The report – written by Alicia H. Munnell, Wenliang Hou and Geoffrey T. Sanzenbacher – examines whether households have a good sense of their own retirement preparedness.
“[D]o their retirement expectations match the reality they face? Do people at risk know they are at risk?” the report asks.
About a quarter of households are overly worried about their retirement finances, the study found, while about a fifth aren’t as worried ad they should be.
First the report looks at the National Retirement Risk Index (NRRI), which measures the percentage of working-age households who are at risk of being financially unprepared for retirement. The NRRI is based on the Federal Reserve’s Survey of Consumer Finances (SCF), a triennial survey of a nationally representative sample of U.S. households.
The NRRI calculations show that “even if households work to age 65 and annuitize all their financial assets, including the receipts from reverse mortgages on their homes,” 52% will be at risk of being unable to maintain their standard of living in retirement.
A comparison with earlier years shows that the situation has become more serious over time. In 1989, 30% of households were at risk of being unable to maintain their standard of living in retirement, which rose to 40% by 1998 and 45% by 2004 before spiking at 53% in 2010.
(The NRRI determines whether a household is “at risk” by calculating a replacement rate — projected retirement income as a percentage of pre-retirement earnings — and compares that replacement rate with a target replacement rate derived from a life-cycle consumption smoothing model. Those who fail to come within 10% of the target are defined as “at risk.”)
To determine if this is an accurate picture of the situation, the report then compares the NRRI to households’ own perceptions of their retirement preparedness.
The Federal Reserve’s Survey of Consumer Finances includes a self-assessment where it asks each household to rate the adequacy of its anticipated combined retirement income from traditional sources: Social Security and employer pensions.
The report finds that in both 2004 (before the financial crisis) and 2013 (the most recent year of data), households’ self-assessment of retirement preparedness is relatively consistent with the NRRI calculations.
“This finding lends support to the notion that the NRRI is accurately detecting a widespread problem,” the report states.
But are these households assessing themselves accurately?
While aggregate perceptions match the NRRI, it does not mean that individual households have a correct assessment. So the report set out to determine the share of households with and without accurate perceptions.
On a household-by-household basis, the report finds that 43% of households in 2013 did not have a good sense of their preparedness.
Among this group, a larger share is too pessimistic rather than too optimistic.
According to the report, 24% of the households fall into the “overly concerned” category, or they report being inadequately prepared but the NRRI says that they are not at risk.
“The likelihood of being in the ‘too worried’ group stems mainly from not fully recognizing the value of potential income from owning a home, being covered by a defined benefit plan, and being eligible for a 50 percent spousal benefit from Social Security,” the report states.
The real danger in terms of misperceptions is being in the “not worried enough” group, according to the report.
The report finds that 19% of households seem to be less worried than they should be, or they report having enough resources to maintain living standards when the NRRI says they are at risk.
Key drivers for being “not worried enough” are having a defined contribution plan and being in the high-income group, according to the report.
“Households with a 401(k) may suffer from ‘wealth illusion,’ not recognizing how little income can be derived from their defined contribution balances,” the report states. “In addition, high-income households may not recognize how much wealth accumulation is required to maintain their standard of living.”
What’s worrisome is that the households that do not recognize that they are at risk are unlikely to undertake remedial action, according to the report.
“Under any circumstance, those households that “worry too little” are the least likely to change their saving or retirement plans,” the report states. “This group accounts for 19% of households, which means that a significant portion of the population needs to get a better assessment of their retirement income needs.”
The report suggests that better educational efforts could help, such as focusing more on the amount of retirement income that a given 401(k) balance could produce rather than the total account balance.
The households that understand they are at risk may need less persuading to act, but they still must act.
“Unfortunately, it is not clear that the 33% that correctly perceive themselves to be at risk will take action either, because of shortsightedness or pressing immediate financial needs,” the report states.
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