The Long Route
Most retirement studies are calculated on the back of an envelope. Not literally, of course. But figuratively, they take shortcuts. They base their conclusions on wealth percentiles rather than the circumstances of individual households, and they determine “success” by measuring whether the assets associated with those percentiles will be able to achieve a specified level of retirement income, which is called a “replacement ratio.”
Morningstar’s Jack VanDerhei and Spencer Look, of the company’s Center for Retirement & Policy Studies, have taken a different, more laborious approach. Beginning with detailed information on 3,442 households, taken from the Federal Reserve’s Survey of Consumer Finances, they then project 1,000 potential life paths for each household, considering potential changes in savings rates, withdrawal patterns, job turnover, and healthcare costs. (Also included are the effects of federal and state taxes, as well as home equity.)
To invoke the jargon, the authors use a stochastic decumulation module—if you drop a term like that at a party, you’ll have people asking you to invest their money (trust me, I know)—that avoids rules of thumb about spending habits. Instead, it evaluates different possibilities for each year of retirement, based on empirical data on retiree expense patterns and health issues.
The result is a model that can thoroughly address a wide variety of questions, which the authors have begun to explore with two initial papers, one published in July and the other in September. This column’s material comes from the second paper. Although it bears a title too long to repeat, it begins with a straightforward and powerful statistic: the percentage of working Americans who should be able to fund 100% of their forecasted retirement needs—including, if necessary, long-term healthcare expenses.
Retirement Preparedness Across 3 Generations
VanDerhei & Look divided their participants into three age cohorts: 1) Generation X, defined as those born between 1965 and 1980; 2) millennials, from 1981 through 1996; and 3) Generation Z, from 1997 through 2012. (With the latter, the authors consider only subjects at least 20 years of age.)
The chart below shows the computed success percentage for each group, assuming the Social Security system remains intact. (Neither presidential candidate appears to harbor the slightest worry about Social Security’s viability, although perhaps that is not quite the assurance you seek.)
Those figures aren’t great, although at least the trend is upward. Then again, when were they better? While I cannot answer that question, I suspect the correct response is “never.” For example, in my immediate family, the success percentage for retirement funding was 25%. My father and brother both lived solely on Social Security a few years after they stopped working, as would have my mother, had she not remarried. Our story is not unique.
The Income Effect on Retirement Preparedness
The averages look much different after adjusting for income levels. The outcomes spike for the wealthiest quartile, as measured by their current age-adjusted earnings. Traditional corporate pensions may have largely vanished, but their twin replacements of 401(K) and IRA plans appear to have filled the retirement-planning gap nicely—that is, for those who have means.
The rich get richer—and they stay that way. The success rate for the top-earning quartile nears 90% for all three generations. That is high by any standards. But the prognosis plummets for paycheck workers, bottoming with a miserable 14% rate for Gen X’s lowest earners.
Such, of course, has always been the fate of the working poor. Even when defined-benefit plans were more prevalent, their occupations were usually excluded, as those jobs were either itinerant (agricultural labor, temporary help) or in fields that didn’t often offer pensions (store clerks, gas station attendants). The results for Gen Z and millennials are somewhat better, but there remains much room for improvement.
Floor Ratios of Retirement Funding
One quarrel with this analysis is that financial outcomes are not binary. Managing a 99% retirement-funding ratio is a modest failure, if at all. In contrast, a 50% ratio is disastrous. Determining when a disappointing retirement outcome becomes life-altering is admittedly arbitrary, but the task should be attempted. I have set that mark at 80%, which I call the “floor” ratio.
That’s a step forward. Three fourths of American workers are on track to achieve a recognizable retirement. To be sure, they may need to curtail their habits—some of which is already incorporated with the authors’ model, which reduces discretionary spending if the investment pool decreases too sharply—but they should be able to maintain a familiar lifestyle.
The income quartiles reaffirm the previous evidence: Few wealthy workers face concerns. A whopping 97% of Gen X employees with top-quartile earnings should obtain at least their retirement floor. In such instances, destitution is likely to arise from very bad fortune or very poor decisions. But the news for their lowest-paid counterparts is dire. The Morningstar paper expects only 29% of them to reach their floor—which, unfortunately, is likely an accurate projection, as the clock is ticking on those retirement dates.
Wrapping Up
Although the details of American retirements have changed, the story remains the same. In the days before 401(k) plans, higher-paid employees were the prime beneficiaries of the nation’s pension system. IBM lifers qualified, strawberry pickers did not. The same principle holds today. Only half of American workers have access to a 401(k) plan, and those who do tend to enjoy above-average incomes.
In short, the common criticism of 401(k) plans is misplaced. They are not worse than the defined-benefit plans that they replaced. As illustrated by the improving fortunes of low-income workers—millennials show greater projected success rates for both the fully funded and floor ratios than Gen X employees, and Gen Z workers show higher rates yet—one could easily interpret the data to boast about the 401(k) system’s accomplishments.
I will not do that. The problem is that, despite the 401(k) industry’s growth, there just aren’t enough such plans to go around. Sure, Gen Z’s low-income workers are outdoing their predecessors, but a 34% success rate for a fully funded retirement is far, far from being good enough. (The 57% success rate for the second-lowest quartile is no prize, either.) Addressing that gap should be the first and highest priority for future retirement legislation.
The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.
