Many Households Misestimate Their Retirement Preparedness

Slightly more than half of working-age U.S. households are at risk of being unable to maintain their standard of living in retirement. Many of these households recognize the possibility of a shortfall, but a large percentage do not.

Slightly more than half of working-age U.S. households (52%) are at risk of being unable to maintain their standard of living in retirement. Many of these households recognize the possibility of a shortfall, but a large percentage (19%) do not.

Two key reasons are potentially to blame. High-income households may misunderstand their savings needs. Social Security benefits replace a lower amount of income for those with high earnings. As such, these households need to contribute proportionately more to their retirement savings to maintain the same standard of living. A defined-contribution plan [e.g., 401(k) plan] balance may also create a “wealth illusion.” This occurs when a large, absolute balance is perceived as being adequate. For instance, a person might think $100,000 is a large sum of savings without considering what it actually means in terms of income (about $400 per month.)

Not all households underestimate their risks. Many properly assess their retirement readiness. Some, however, err on the side being too worried (24%). These people may not realize they can or otherwise do not plan to tap their home’s equity. To the extent that they have a pension, they may underestimate the value of a prospective lifetime income stream. These households may also not be aware that Social Security pays a 50% spousal benefit to non-working and lower-earning spouses.

The data on household preparedness and perceptions is derived from the National Retirement Index (NRRI). The NRRI is based on the Federal Reserve’s triennial Survey of Consumer Finances (SCF). The index calculates projected retirement income as a percentage of pre-retirement earnings. This replacement income is then compared against a life-cycle consumption model. Households below 10% of the model’s target are defined as being “at risk.”

As noted above, 52% of working-age households were at risk as of 2013. This is down slightly from 53% in 2010, but far above the 30% level recorded in 1989. Even as recently as 2007, less than half of households were at risk (44%). Increases in life expectancy, declines in the percentage of salary Social Security replaces and the shift from pensions to 401(k) plans are all contributing to the increasing proportion of households that are at risk.

Source: “Do Households Have a Good Sense of Their Retirement Preparedness?,” Alicia Munnell, Wenliang Hou, and Geoffrey Sanzenbacher, Center for Retirement Research at Boston College, February 2017.