©2004 AARP: This report is reprinted with the permission of the American Association of Retired Persons.
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Foreword
Baby boomers have often been characterized as the profligate offspring of the depression-era savers now known as the "greatest generation." Newspaper headlines frequently warn that aging boomers are headed for financial catastrophe in retirement because they are not saving enough. We also see stories, albeit less frequently, that boomers will be the richest generation in history. Some have argued that boomers will inherit anywhere from $10 trillion to $40 trillion in wealth, which yields between $132,000 per boomer (which is more than the median boomer household had accumulated by 2001) and $560,000 per boomer. Can these seemingly conflicting stories be reconciled?
Divining the retirement fate of baby boomers has become a regular preoccupation of journalists and pundits, who know that stories about boomers are sure to capture the rapt attention of that most educated, numerous, and (some would say) self-absorbed generation in American history. But the answer to the question of the adequacy of boomer retirement preparation is an elusive one. The preponderance of the punditry seems to suggest a pessimistic conclusion, but some of the best work on the subject is more optimistic.
Part of the difficulty in projecting boomers' retirement security is that the youngest boomers are still at least 20 years from retirement, so that projecting their retirement preparation is somewhat hazardous, while the oldest boomers are a mere four years from Social Security early retirement eligibility. An added difficulty is that boomers and even near-retirees show signs of staying in the work force longer, which can strongly influence retirement calculations. In addition, few data sources permit the estimation of total retirement wealth, because they lack information on one or more components of wealth. In particular, numerous wealth studies omit information about wealth from Social Security or defined benefit (DB) pension plans. Another issue is defining the standard of adequacy. Some have compared boomers' resources with those of their parents at similar ages, and some have argued that adequacy should relate more to boomers' own preretirement income, not to their parents' income.
This paper by Barbara Butrica and Cori Uccello of The Urban Institute overcomes many of these problems, and sheds welcome and much-needed new light on the retirement fate of boomers. Using The Urban Institute's DYNASIM model, the authors project wealth out to age 67 for boomer age cohorts as well as their predecessors. DYNASIM projects all forms of retirement wealth—pension, Social Security, and non-pension wealth—to 2050, providing a more comprehensive picture of retirement wealth. The story that Butrica and Uccello tell about boomers' retirement preparation is a much more nuanced version than is found in journalistic accounts. Although boomers will accumulate more wealth and receive more income than their predecessors, they will not enjoy higher replacement rates. Early boomers will have replacement rates similar to those of their predecessors, while late boomers are less likely to maintain their pre-retirement standard of living. Furthermore, the steady improvement in well-being we have come to expect does not show up in the second half of the boomer generation.
Butrica and Uccello's study provides important new evidence on the adequacy of boomers'
retirement resources. Their findings serve as a cautionary note that the complete story of boomer
retirement security is considerably more complex than has been portrayed.
John R. Gist
Associate Director
AARP Public Policy Institute
EXECUTIVE SUMMARY
Background
The economic well-being of future retirees in the baby boom cohort—those born between 1946 and 1964—is of particular concern to policy-makers. The oldest boomers will be eligible for Social Security retirement benefits in fewer than 10 years, and even the youngest boomers are approaching middle age. Yet there is still much speculation on how this birth cohort will fare in
retirement.
Purpose
The aim of this study is to provide new evidence on the adequacy of boomers' retirement resources. Using the Urban Institute's Dynamic Simulation of Income Model (DYNASIM), the study addresses the following questions:
- What are the projected levels of wealth at retirement for current and future retirees?
- What are the projected levels of income at retirement for current and future retirees?
- What replacement rates will boomers be able to achieve, and will poverty rates among
boomers increase or decrease relative to earlier retiree cohorts?
Methodology
In this study, we use The Urban Institute's DYNASIM model to project wealth at age 67 and compare the overall levels, composition, and distribution of wealth among the boomer cohorts with those of retirees from earlier cohorts. Then we evaluate the adequacy of retirement resources by estimating the income that could be generated from wealth at retirement. We project replacement rates and poverty rates among boomers and compare them with those of retirees from earlier cohorts. Finally, we examine the extent to which demographic and labor force changes may have contributed to any projected changes in economic well-being in retirement.
The DYNASIM model starts with a self-weighting sample of about 100,000 individuals from the 1990 to 1993 Survey of Income and Program Participation. DYNASIM ages this starting sample in yearly increments, to 2050, using parameters estimated from longitudinal data sources. The model integrates all of the important trends and differentials in life course processes, including birth, death, schooling, leaving home, first marriage, remarriage, divorce, disability, work, and earnings. DYNASIM also simulates pension, Social Security, and nonpension wealth. Using these projections we can construct a comprehensive measure of wealth in retirement.
DYNASIM is a useful tool for gaining insights into what we expect to happen to the retirement incomes of future retirees. It projects Social Security benefits and other important sources of income in retirement. DYNASIM also accounts for major changes in the growth of economy-wide real earnings, the distribution of earnings both between and within birth cohorts, and the composition of the retiree population. All of these factors will affect the retirement income of future retirees.
Principal Findings
Projected Wealth at Age 67. According to DYNASIM projections, boomers will amass more wealth in real terms (2003 dollars) at retirement than will the previous two birth cohorts. Average household wealth at age 67 will grow from $558,000 among current retirees to $703,000 among today's near-retirees to more than $800,000 among boomers. Interestingly, late boomers will experience a dip in average wealth relative to early boomers. Early boomers are expected to accumulate wealth of $859,000 and late boomers only $839,000. Nevertheless, even the late boomers will accumulate more wealth than will the cohorts of current and near-retirees.
Total retirement wealth (including Social Security wealth, defined benefit [DB] pension wealth, and retirement account wealth) increases steadily across all cohorts, but different trends emerge among the different components of retirement wealth. Like average total retirement wealth, average Social Security wealth increases steadily across cohorts. But average DB wealth decreases, from $90,000 among the cohort of current retirees to $62,000 among the late boomers. (DB wealth among women increases, however, reflecting their increasing DB coverage and labor force participation.) The increase in retirement account wealth more than offsets the decline in DB wealth. Average retirement account wealth (including defined contribution [DC] retirement plans, IRAs, and Keoghs) increases dramatically, from $34,000 among current retirees to $140,000 among late boomers.
Non-retirement wealth (including financial wealth and housing wealth) increases by cohort, but then decreases among the late boomers. The drop in non-retirement wealth among late boomers relative to early boomers is concentrated among married couples and in large part reflects shifting demographics. Among married men, late boomers are more likely to belong to a racial or ethnic minority than early boomers and are less likely to have a college degree. Both of these shifts contribute to lower wealth among the late boomers. In addition, late cohorts are more likely to hold non-collateralized debt, such as credit card debt or student loans. The drop in housing wealth likely reflects many factors, including declining family size and other demographic shifts among future cohorts that will reduce demand, and increases in the prevalence of 30-year mortgages and home equity loans, which slow the accrual of housing equity. Furthermore, earlier cohorts enjoyed rapid increases in housing values in the 1960s and 1970s that later cohorts did not experience.
Median wealth, which is lower than average wealth, exhibits similar trends by wealth source. The one exception is that while the late boomer cohort experiences a dip in average wealth compared with the early boomer cohort, no such dip occurs among median wealth holders. Although the late boomers do experience a drop in non-retirement wealth, this drop is more than offset by the increase in retirement wealth. Because Social Security wealth constitutes a larger share of total wealth among median wealth holders, increases in Social Security wealth by cohort are more important among this group, and they can offset drops in other wealth sources.
Projected Income at Age 67. Consistent with trends in wealth at retirement, income at retirement is projected to be higher for future retirees than for current retirees. Projected household income at age 67 will increase from $44,000 among current retirees to $65,000 among early and late boomers. Similar to the patterns in wealth, non-retirement income is expected to decline between the early and late baby boom cohorts, but increases in retirement income are expected to offset decreases in non-retirement income.
The importance of particular income sources is projected to change over time. For instance, the share of total income at age 67 from household earnings is projected to increase among the baby boom cohorts, reflecting a greater likelihood of working at that age among women. In addition, the share of total income from retirement accounts is projected to increase among the baby boom cohorts. Although the share of DB pension income is projected to decrease, this loss is more than offset by an increase in income from DC retirement plans.
Project ed Adequacy of Retirement Income. Early boomers are expected to achieve replacement rates that are very similar to those of current retirees. In contrast, late boomers are expected to have lower replacement rates than current retirees, despite having higher real incomes. Median replacement rates, computed as the ratio of per capita household income at age 67 to average per capita shared earnings between ages 50 and 54, are projected to be between 86 and 88 percent (i.e., per capita household income at age 67 will replace 86 to 88 percent of average per capita shared earnings) for current retirees, near-retirees, and early boomers. Replacement rates are expected to decrease to 80 percent for late boomers. However, the replacement rate calculation included any household earnings plus SSI benefits in the numerator of the ratio, and adding these two items makes a substantial difference for both boomers and for current and near-retirees. Without earnings and SSI added, replacement rates were projected to be 71 and 67 for current and near-retirees, respectively. For early and late boomers they are projected to be 68 and 63. Thus, the patterns are the same, but the replacement rates without earnings and SSI benefits are substantially lower. With some exceptions, these patterns persist for various subgroups. Because of the projected deterioration in replacement rates over time, late boomer retirees will be less likely than current retirees to maintain their pre-retirement living standards.
In contrast to replacement rates, poverty rates assess well-being on a more absolute scale. The projected increase in retirement incomes between current retirees and baby boom cohorts will reduce poverty rates for most men and women. Overall, projected poverty rates at age 67 will decrease from 8 percent among current retirees, to 5 percent among today's near-retirees, to 4 percent among early boomers, and to 2 percent among late boomers. This decline in poverty largely reflects the effects of higher real earnings on real Social Security benefits and other retirement income for baby boom retirees relative to earlier retirees. (In contrast to the Census income measure that includes only money income, DYNASIM poverty rates are calculated using a more comprehensive measure of income that includes annuitized income from financial assets. Because this more comprehensive income measure better gauges a household's ability to meet consumption needs, DYNASIM income projections are higher and poverty rates are lower than those calculated using the Census income measure.)
Nearly all demographic and economic subgroups will experience declines in poverty rates over time, and subgroups with the highest poverty rates among the cohort of current retirees enjoy the largest reductions. Nevertheless, certain boomer subgroups will remain especially vulnerable. For instance, never-married women in the boomer cohorts will have poverty rates between three and four times the average rate for their cohort, and divorced women will have rates more than twice the average. To a lesser extent, never-married men will also have higher-than-average poverty rates. In addition, blacks, Hispanics, individuals without high school degrees, and those with fewer than 20 years in the labor force are projected to have higher poverty rates than average. Because of the correlation between pre-retirement earnings and postretirement earnings, retirees with the lowest lifetime earnings also have higher-than-average poverty rates.
We also examine poverty rates under alternative scenarios. Reducing current and future Social Security benefits by 13 percent, an amount that would keep the trust funds in balance over the next 75 years, would increase adjusted poverty rates only slightly. In contrast, using a threshold of 200 percent of the federal poverty level as a proxy for increased health costs and other potential consumption needs of the elderly could quadruple the share of retirees unable to meet their consumption needs.
Finally, if a goal of policy is to prevent retirees from falling behind relative to average living standards of workers, then it is also important to assess retirees' incomes relative to workers' incomes. Using this measure of retirement well-being, we find that retirees are far more
likely to have per capita incomes less than 45 percent of the national average wage (the definition of low-wage workers used by Social Security actuaries) than they are to have incomes below the poverty threshold. Unlike poverty rates, which are projected to decline over time, the share of retirees with per capita incomes less than 45 percent of the national average wage is projected to remain at about one-third.
Conclusion
As the boomer cohorts move toward retirement, it is increasingly important to assess their prospects for retirement security. This study uses the Urban Institute's DYNASIM model to project wealth and income at retirement for current and future retirees. The results point to some signs for optimism. The boomer cohorts are expected to accumulate more wealth and to receive more income in real terms at retirement than will previous generations. However, relative to early boomers, late boomers will accumulate less wealth and receive no more income at retirement. Although demographic shifts account for much of the decline among late boomers, projected declines in financial wealth could also result in part from decreased saving among late boomers.
The news on whether the increased income and wealth at retirement among boomers translates to better well-being in retirement is also somewhat mixed. On the one hand, well-being in retirement relative to well-being during working years, measured by replacement rates, is expected to increase only marginally among early boomers and to decline for late boomers. Although their real incomes will be higher than those of earlier cohorts, boomers will not achieve higher replacement rates in retirement than will current retirees. In fact, late boomers will be less likely than current retirees to maintain their pre-retirement standard of living.
On the other hand, poverty rates are projected to decline substantially over time, in large part because of the effects of higher earnings on real Social Security benefits and other retirement income and the fact that poverty thresholds are not adjusted to reflect real-wage increases over time. Nevertheless, certain boomer subgroups will remain especially vulnerable, including never-married and divorced women, blacks, high school dropouts, and those with a weak labor force attachment. Furthermore, the share of retirees with per capita incomes less than 45 percent of the national average wage is projected to remain relatively constant over time, suggesting no improvements in well-being of retirees compared with that of workers.
In other words, our conclusions differ depending on whether economic well-being is assessed on an absolute or a relative basis. In absolute terms, measured by real household incomes and poverty rates, boomers will be better off than current retirees. But in relative terms (e.g., post-retirement income relative to pre-retirement income and relative to workers' incomes), boomers will be no better off or in some cases worse off than current retirees.
Our findings are more optimistic than those of some other studies that have assessed the adequacy of retirement savings. A key difference between DYNASIM projections and other estimates is that DYNASIM projects a broad measure of income that includes not only Social Security and private pension income but also income from earnings and annuitized income from financial assets. This more comprehensive measure better gauges the household resources available to meet retirement consumption needs. Even with this more comprehensive income measure, though, our results suggest that boomers, especially those at the tail, need to increase their savings or work longer if they desire to maintain their real living standards. This additional savings might not be as much as earlier studies suggest, however.
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