Why Boomer Retirement Balance Sheets Are a Mess

Conversations about retirement readiness usually focus on portfolios--how much you're saving, your investment mix, and whether you'll accumulate assets sufficient to last a lifetime.

But those conversations are missing a bigger-picture question about retirement readiness: How are household balance sheets shaping up as families approach retirement?

A new study by the AARP Public Policy Institute provides answers. AARP researchers used highly authoritative Federal Reserve household survey data to create balance sheets showing average amounts of assets, debt, and net worth for the American middle class for young, middle-age, and older households.

The study quantifies what many of us know intuitively: The balance sheets of pre-retired Americans are a mess. Middle-class Americans close to retirement (50-64) experienced a 22.4% drop in net worth during the Great Recession (2007-10). The only cohort that saw a larger decline was the 25-49 age group (44.9%), but they also have more years to rebuild wealth before retirement.

On the assets side of the ledger, the stock market isn't the key culprit here. The market is up strongly over the period studied (1989-2010). But wage growth has been stagnant. The economy went through three recessions, damaging employment security. And the value of nonfinancial assets, chiefly real estate, has fallen sharply--the hangover of the housing bubble and bust. Meanwhile, on the liabilities side of the ledger, debt has swelled.

The research is based on what is widely regarded as a gold standard of economic surveys--the Federal Reserve Survey of Consumer Finances, or SCF. The SCF is conducted every three years and gathers detailed information on the finances of U.S. families. It is based on in-depth interviews with roughly 6,500 families across all economic segments--and participants are interviewed again for subsequent studies in order to measure trends with accuracy.

The AARP study relies on the most recent Federal Reserve survey data from 2010, and balance sheets likely have recovered some since then as the economy--and the housing market in particular--have started bouncing back.

AARP researchers used the SCF data to create middle-class balance sheets for younger households (ages 25-49); pre-retirement households (ages 50-64); recent retirees (ages 65-74); and older retirees (ages 75+). The study examined what's been happening just since the recession (2007-10) as well as longer-term trends (1989-2010). "Middle class" is defined as families with income between the 20th and 80th percentiles--in 2010, ranging from $20,330 to $94,535).

Key Findings
Here are some of the highlights--or perhaps lowlights--of the AARP research:

Pre-retiree debt/asset ratios (total debt divided by total assets) have jumped sharply.
Debt levels started climbing sharply before the recession, and accelerated through the downturn--especially among pre-retirees (see the data below). Although younger age groups have higher overall debt ratios, since 1989, Americans over age 50 have experienced the sharpest rates of increase in debt of any age group. The result: Even though the stock market was substantially higher in 2010 than in 1989, financial stability of middle-class pre-retirement families has not improved.

These households likely will carry more debt into retirement than their parents did. "It's difficult to get rid of debt when you get into your 60s or 70s," says Debra Whitman, an economist and executive vice president for policy and international at AARP. "It's more difficult to go back to work, so your income is fixed. Younger people have a lifetime of work ahead to pay off their debt."

Net worth is stagnating or falling for most age groups.
Long-range net worth (1989-2010) rose substantially among the oldest age groups but was up just 5% among pre-retirees. And it plunged for people ages 25-49 (down 32%). The story is much uglier in the recession years: net worth fell 22% among pre-retirees and 45% among 25- to 49-year-olds. Families over age 65 enjoyed the sharpest gains in long-term net worth and came through the recession with the smallest losses.

Boomers face intergenerational challenges.
Families in the 50- to 64-year-old group are struggling to finance their children's education, accumulate retirement savings, and assist parents with financial or caregiving needs. Average education debt was 437% higher in 2010 than in 1989, and 46% higher than before the recession, according to SCF data.

Oldest households face more risk.
The oldest household group (75+) came through the recession with an average drop of 16% in net worth. But one surprising statistic is a whopping 29% drop in financial assets from 2007 to 2010. That statistic suggests older Americans had too much exposure to equities for their age--perhaps because of the ultralow interest-rate environment.And more older families are borrowing than in the past. In particular, households over 75 have sharply higher credit card balances--31% higher in 2010 than before the recession.

What's going on inside the numbers? The housing bubble-and-bust is the most important driver. "The low interest rates over the past two decades made it more attractive to take on more home mortgage debt," says Dan McCue, research manager at the Joint Center for Housing Studies at Harvard University.

"Rapid price appreciation was another important factor," he adds. "It gave homeowners the ability to realize gains in housing prices and turn into spending. Mortgage products like second loans and cash-out refinancing were being done at record-high rates in the last decade. It really was just converting a lot of the gain in home equity into spendable money that was used for home repairs, remodeling, and general consumption."

The Implications
The balance sheet analysis underscores a number of key issues and policy questions about the future of American retirement security, including:

Bolstering guaranteed income
Only one third of private-sector workers hold a traditional pension, down from 88% in 1975, according to the National Institute on Retirement Security. That leaves Social Security as the sole source of guaranteed income for most. And boomers, gen-Xers, and millennials will be more reliant on Social Security than today's seniors. Although much of the Washington debate focuses on cutting benefits to reduce federal deficits, we'd be smarter to beef up benefits. A recent poll shows a strong majority would be willing to pay higher taxes to do just that.

Policymakers have advanced creative ideas for new pension programs that resemble defined-benefit plans. Sen. Tom Harkin (D-Iowa) has proposed a mandatory cash-balance defined-benefit program for employers who do not offer a minimum level of retirement benefit via automatic payroll deduction. California is looking at creating a government-sponsored retirement-savings vehicle that would be offered to employees of every California company that doesn't have a workplace retirement plan.

Improved access to workplace saving
Just 42% of private-sector workers ages 25-64 have any pension coverage in their current job, according to the Center for Retirement Research at Boston College. The problem is most acute among low- and middle-income workers and those who work for small companies.

The Obama Administration has advocated creation of Auto-IRAs--a plan that would require employers with more than 10 employees and no pension coverage to contribute 3% of the worker's salary into an IRA that benefits from various tax credits.

Beefing up the existing federal Retirement Savings Contribution Credit is another good idea.

"We certainly need more access to workplace savings," says Whitman. "A small amount taken out of a paycheck every month is the best way to build a nest egg, especially when you're young."

Resources
A wide array of AARP's reports on middle-class security can be found here. And details on the Federal Reserve Survey of Consumer Finance are here.

Links to online tools and resources for maximizing Social Security benefits are here.

My recent Morningstar column on new ideas for bolstering guaranteed income in retirement can be found here.

Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.

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