Sunday, January 26, 2014

Safety “Net”

I’m one of those travelers who absolutely dreads cutting it to the last minute. Not that I haven’t been forced to do so, from time to time, but I’m generally the one chomping at the bit to get to the airport, or to hit the highway an hour before anyone else. In my defense, on more than one occasion that “cushion” has been the difference between catching a flight or not. Planning that only considers a “best” or “normal” scenario too often overlooks the unexpected—and sometimes that margin of error is all you have.

For over a decade EBRI has modeled the nation’s potential retirement savings shortfall, and the EBRI Retirement Readiness Ratings™ provide an assessment of how many Americans are at risk of running short of money for needed expenses in retirement. In contemplating expenses, that model considers the regular expenses of living in retirement, as well as uninsured medical expenses, and the potential costs of nursing home care.

However, we have also documented and quantified the role of Social Security, defined benefit and private retirement accounts on retirement income adequacy for Baby Boomers and Gen Xers with an eye toward replacing their preretirement wages and income. While this more traditional focus on income replacement may misstate an individual’s actual post-retirement financial situation, many financial planners work with this goal as a starting point, and it can provide valuable insights particularly when—as is the case with EBRI’s projections—it is able to leverage actual 401(k) data from the unique EBRI/ICI 401(k) database, the largest such repository in the world.

Indeed, based on a recent EBRI analysis, between 83 and 86 percent of workers with more than 30 years of eligibility in a voluntary enrollment 401(k) plan are simulated to have sufficient 401(k) accumulations that, combined with current levels of Social Security retirement benefits, will be able to replace at least 60 percent of their age-64 wages and salary on an inflation-adjusted basis.

When the threshold for a financially successful retirement is increased to 70 percent replacement of age-64 income, 73–76 percent of these workers will still meet that threshold, relying only on 401(k) and Social Security combined. At an 80 percent replacement rate, 67 percent of the lowest-income quartile will still meet the threshold; however the percentage of those in the highest-income quartile deemed to be “successful” relying on just these two retirement components slips to 59 percent, reflecting the progressive nature of Social Security.

As positive a result as that seems for many, when the same analysis is conducted for automatic enrollment 401(k) plans (with an annual 1 percent automatic escalation provision and empirically derived opt-outs), the probability of success increases substantially: 88–94 percent at a 60 percent threshold; 81–90 percent at a 70 percent replacement threshold; and 73–85 percent at an 80 percent threshold.

That’s not quite the doomsday crisis scenario portrayed by many of the headlines in vogue today, though EBRI’s projections still show that a large number of Americans—even among those eligible for a 401(k) plan for 30 years—won’t be able to replace that pre-65 salary even at the various levels modeled, based on current savings patterns.

It does, however, illustrate the impact that changes in those current savings behaviors can have—and it underscores the significant role of Social Security as a vital safety net for the nation’s retirement security.

Nevin E. Adams, JD

“The Role of Social Security, Defined Benefits, and Private Retirement Accounts in the Face of the Retirement Crisis” is available online here.

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