Taking the optimistic view.
I have been working with two Morningstar colleagues on a white paper about the U.S. retirement system (scheduled for November release). Part of that task requires reviewing the existing research. One of the best overviews is Retirement: Are Americans Preparing? by Peter Brady of the Investment Company Institute.
Unlike many retirement researchers, Brady finds the glass to be half full. This column summarizes those arguments. They are not points that you have necessarily heard, because most discussions of the U.S. retirement system are unrelievedly gloomy, describing a “crisis” that seemingly cannot be averted. The news, as we shall see, is not that bad.
That said, Brady takes a decidedly upbeat view of the matter--as is to be expected from somebody who represents mutual funds, which occupy the center of the current retirement structure. The glass is indeed half full, but that does leave the other half empty. Tuesday’s upcoming column, “4 Negative Signs for U.S. Retirements,” will take the other side of the debate.
Declining Poverty Rates
Overall, U.S. poverty rates have been roughly stable since 1970, even as overall wealth (as measured by per-capita gross domestic product) has doubled. That is a disappointing outcome and has justifiably stimulated much discussion. One would hope and expect that a rising economic tide would lift more boats, rather than the same number of boats that it had previously supported.
The elderly have been a happy exception. As the '70s began, the elderly had the highest poverty rate among the three major age cohorts. Per U.S. Census Bureau estimates, their rate was at 20%, with children at 15%, and those of a working age just under 10%. Today, those positions have reversed. The elderly are now best off, at 10%, with the rate for workers having risen to 15%, and that of children to 20%.
Current poverty rates are but one way to gauge wealth, and they don’t measure the prospects of those who have yet to retire--which is, after all, the topic at hand. Nevertheless, this statistic should give pause to those who predict retirement doom. For almost half a century, according to a basic and important measure, the demographic that gives those researchers the most concern has fared the best.
Social Security’s Strength
Yes, I know. It’s a fair question whether the Social Security Administration can sustain its payment schedule. (This being a highly politicized subject, it’s also fair to question the questioners.) Let’s assume for this discussion that it can, at least for the upcoming generation of retirees.
That does a pretty good job of addressing the very neediest Americans, those placing in bottom of the SSA’s five income buckets: very low earners. The SSA estimates that for such workers, Social Security payments will cover from 77% to 87% of their income replacement rates (the estimates vary according to the assumptions). Those percentages drop precipitously for higher earners--but almost all of them have at least some defined-contribution and/or IRA assets by the time of retirement.
That Social Security can replace so much of the lowest wage earner’s income is by no means an unambiguous good. There is more to be said on that matter--and will be in Tuesday’s column. But it is reassuring that Social Security most benefits those who most need the help. That is according to plan.
Holding Steady Outside of Social Security
Those who bemoan the shift from defined-benefit pension plans to defined-contribution plans (that is, 401(k)s) sometimes give the impression that this has led to a decline in retirement coverage; that is, fewer retirees have assets outside of Social Security. That is not so. In 1989, 79% of households that had a working head aged 55 to 64 had a defined-benefit plan, a 401(k) plan, and/or an IRA. Twenty-five years later, that figure was 81%.
To be sure, the mix has changed. The percentage of upcoming retirees who will receive defined-benefit payments has been halved, with the gap, unsurprisingly, filled by 401(k)s, which have greatly expanded over that quarter century. (The percentage of current retirees who receive defined-benefit checks, believe it or not, is actually highertoday--but that is a lag effect, and those numbers will be coming down over the next few decades.) But the details of the blend are less important than the overall result: Upcoming retirees are holding steady.
Once again, there is a flip side to this statistic. Matching the achievement of the 1980s is only a victory insomuch as the '80’s retirement system was a victory. It was not. There is no question that U.S. retirement planning is imperfect. On the issue of asset coverage, though, it is no more imperfect than before.
Will Less Be More?
I approach the final item carefully because it is a complex topic and is very much unsettled. Suffice it to say that some researchers believe that standard estimates of retiree preparedness are too conservative. They don’t account for all assets, and they overstate how much money retirees spend. Even modest differences in such assumptions can lead to wide discrepancies for the final projections.
Thus, points out Brady, whether the U.S. faces a retirement crisis depends largely on what source is cited. The National Retirement Risk Index finds that only 48% of Americans are on track to have a financially adequate retirement, as it defines the outcome. That, clearly, is terrible. Nobody would call a 48% pass rate anything but a failure.
Still weak but heading north are forecasts from EBRI at 57% and Hurd & Rohwedder at 71%. Most optimistic is the outlook from Scholz & Seshadri, who calculate that 84% of Americans are on track for an acceptable retirement. That would seem to qualify as a success for a country that does not mandate retirement savings from either the employer or employees, save for the insurance program of Social Security.
It would be irresponsible to seize the highest of these predictions, call that the truth, and declare the U.S. retirement system to be sound. My point is only to instill doubt. Those who seize upon the lowest estimates and pronounce that the system is broken may indeed be correct. But there remains the possibility that they are not, and that if measured according to best practices, that retirement readiness is better than has been generally advertised.
If this column has you feeling cloyed, never fear--Tuesday’s installment will cut the sugar!
John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.