‘End’ Adequate? Are We Getting an Accurate Read on Retirement Readiness?

The title of a new report by the Society of Actuaries poses an intriguing question: “Retirement Adequacy in the United States: Should We Be Concerned?”

When all is said and done, the answer from the report’s authors seems to be “it depends.”

And, as it turns out, it depends on a lot of things: who is asking the question, who you are asking the question about, and what you think the answer should be. And that doesn’t even take into account the questions about the assumptions one makes to come up with the answers.

The SOA report draws some conclusions:

• The current system of voluntary employment-based retirement plans has been largely successful from the perspective of companies sponsoring plans for individuals with long-term employment covered by such plans.
• The mandatory Social Security system has done much to reduce poverty in old age, though adequacy studies using replacement ratios may overstate the success of this safety net for those in the lowest-income groups, because too many rely solely on Social Security as their sole source of support. Moreover, for households that don’t have access to employer-sponsored retirement plans, Social Security alone will not allow them to maintain their preretirement standard of living.
• There is a need for future research that delves into the retirement challenges of particularly vulnerable populations, such as those who are widowed, divorced, long-term disabled or long-term unemployed.

But when it comes to answering the question posed in the title – well, the report’s authors concede that “significant differences in methodologies that are used in retirement adequacy research makes direct comparisons of results more difficult.” Specifically that most studies:¹

• do not adequately account for major unexpected expenses or shocks, such as poor investment performance, long-term care, death of a spouse and unexpected out-of-pocket medical expenses;
• assume that the adequacy objective is to maintain pre-retirement living standards (surveys indicate retirees are willing to live more conservatively);
• assume that people retire at a “normal” retirement age; and
• differ significantly in their treatment of housing wealth (if housing wealth is accessible to meet retirement needs, overall adequacy is higher).

The report also offered some cautionary notes, specifically that:

• You need to consider the source(s). “Different stakeholder groups are asking different questions, offering different solutions and measuring success in different ways.”
• Reliance on replacement ratios can be misleading. While they are easily explained, can be compared over time, and may be used for individuals, groups of individuals or the entire retiree population, “there is no universally agreed-upon definition or consensus on what constitutes an adequate replacement ratio or on how to adjust for differences in individual circumstances.”
• Post-retirement spending patterns can, and do, vary. Lifetime spending needs are also highly dependent on the length of the retirement period, changes that occur over time and whether a household experiences a spending shock during retirement. On the one hand, focus group and survey data show that most retirees are frugal and are satisfied with a lower standard of living in retirement than what is considered adequate in most research studies. However, large expense shocks “have a significant negative effect on retiree finances,” and many models ignore those impacts.

Ultimately, they conclude that some studies conclude that there is a retirement crisis in the United States and while others conclude that the system is in good shape – inconsistent outcomes that the authors say can be shown to be due to differences in research objectives, methodology, assumptions, definition of adequacy and population studied.

“The truth is that our retirement system has both successes and failures.”

Here’s to maximizing the first, and whittling away at the second – and not getting distracted by headlines in the meantime.

- Nevin E. Adams, JD
 
Footnote

1. However inconsistent current reports are, things might be worse when it comes to considering the current state versus future retirements. The report notes that many of the current studies fail to take into account the impact of changes in retirement ages, phased retirement and work during retirement. And that most studies focus on the retirement adequacy of current and near retirees, although retirees of the future may face more difficulty than today’s retirees “because of demographic issues, high debt load, lower likelihood of being married and owning a home, potential future reforms to Social Security, shifts in employment, and changes in the structure of employee benefit plans.” ↩