RETIREMENT SAVINGS OF AMERICAN HOUSEHOLDS: ASSET LEVELS AND ADEQUACY

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1 RETIREMENT SAVINGS OF AMERICAN HOUSEHOLDS: ASSET LEVELS AND ADEQUACY Report to the Consumer Federation of America and DirectAdvice.com Catherine P. Montalto, Ph.D. Consumer and Textile Sciences Department College of Human Ecology, The Ohio State University 1787 Neil Avenue, Columbus, Ohio Phone: Fax: April 26, 2000

2 RETIREMENT SAVINGS OF AMERICAN HOUSEHOLDS: ASSET LEVELS AND ADEQUACY Introduction The types of retirement savings of American households, the levels of these savings, and the ability of retirement savings to maintain the household s pre-retirement level of living during retirement were studied using data from the 1998 Survey of Consumer Finances. The data were released by the Federal Reserve Board this past February and provide the best and most recent information on retirement savings of American households. The adequacy of retirement savings refers to whether the resources (from personal savings, private pensions, and Social Security) projected to be available for spending during retirement are greater than retirement needs. Yuh, Montalto, and Hanna (1998) conducted a similar analysis using data from the 1995 Survey of Consumer Finances. To estimate resources available for spending during retirement, the accumulation of current assets (financial and nonfinancial) is projected for each household using asset specific growth rates. The accumulated value of these assets is added to the present value of future retirement income from pensions and Social Security. Retirement needs are estimated with a household expenditure function that allows expenditure to vary by household income, spending behavior, life cycle stage, and housing tenure. The point of retirement is defined as the age at which the respondent indicates s/he plans to stop working full time. Data The data analyzed in this study are from the public use tape of the 1998 Survey of Consumer Finances released by the Federal Reserve Board in February The Survey of Consumer Finances (SCF) is a triennial survey that provides comprehensive and detailed information on household financial and nonfinancial assets, including individual retirement accounts and employer provided retirement plans through current and past employment. The 1998 SCF provides the best and most recent information on retirement savings of American households and is well suited for this study, providing information on a broad age-range of the population, including both pre-retired and retired households. (For more descriptive information about the 1998 SCF refer to Kennickell, Starr-McCluer, and Surette, 2000.) A total of 4,309 households were interviewed in the 1998 SCF 2,813 from the area probability sample and 1,496 from a special list sample. The area probability sample provides good information on characteristics that are broadly distributed in the population, like home ownership. The special list sample over samples households that are likely to be relatively wealthy in order to obtain good information on the upper tail of the wealth distribution where less widely owned assets, like noncorporate businesses, are concentrated. The SCF final nonresponseadjusted sampling weight (X42001) accounts for both the systematic properties of the sample design and differential patterns of nonresponse, and is used to generate estimates that are representative of all households in the U.S. C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 1

3 Types and Levels of Retirement Savings Retirement savings of American households include both non-employer retirement plans and employer-sponsored retirement plans. (Descriptions of types of retirement assets are provided on page 7). Non-employer retirement plans are commonly referred to as individual retirement accounts, and include IRAs and Keogh accounts. These accounts allow wage and salary workers, and self-employed workers, respectively, to make tax-deductible contributions to retirement accounts and accrue earnings on the accounts tax-free until withdrawal. Employer-sponsored retirement plans include plans through current and past jobs, as well as current receipt of retirement benefits (excluding Social Security). Employer-sponsored retirement plans through current jobs can be broadly classified into defined-benefit pensions and defined-contribution plans. Defined benefit pension plans provide a guaranteed benefit based on workers salaries and years of service. Defined contribution plans enable the employer, the employee, or both to contribute money during the working years to a fund for the payment of retirement benefits to the covered worker. The level of the retirement benefit depends on the accumulated value of the fund. Ownership of any retirement asset Over 60% of American households own some type of retirement asset (Table 1). Ownership of retirement assets increases with household income and with education of the householder. The percent of households with retirement assets increases from 13% for households with annual income below $10,000, to 72% for households with annual income between $25,000 and $50,000, to 94% for households with more than $100,000 in annual income. Only 38% of households with a householder who has not graduated from high school own retirement assets, compared to 58% when the householder is a high school graduate, and 80% when the householder is a college graduate. There is a nonlinear relationship between ownership of retirement assets and current age of the householder. Less than 50% of households with a householder under age 35 own any retirement asset, compared to 67% of households with a householder between ages 35 and 44, and 70% of households with a householder between 45 and 64 years old. The percent of households that own retirement assets falls to 60% when the householder is 65 or older. Households with white non-hispanic householders are more likely to own retirement assets than households with a householder from a racial/ethnic minority group. Households with a married householder are more likely to own retirement assets than households with an unmarried householder. Ownership of retirement assets also varies by Census region, with ownership highest for households in the North Central region and lowest for households in the South region. Ownership of non-employer retirement plans. Over 28% of American households have an IRA or Keogh account. The variation of ownership by household characteristics mirrors the patterns observed for retirement assets. The impact of household annual income is very strong. The percent of households with IRA/Keogh accounts increases from 4% for households with annual income below $10,000, to 65% for households with more than $100,000 in annual income. C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 2

4 Ownership of employer-sponsored retirement plans. Nearly 54% of American households have an employer-sponsored retirement plan through a current job or through a past job from which future retirement benefits are expected, or currently receive retirement benefits. Eighteen percent of households have a defined-benefit pension plan while 33% have a defined-contribution plan (401k and 403b) through a current job. Among households with a defined-contribution plan on a current job, nearly 83% have employers who make contributions to the plan. Lower income households are least likely to participate in these retirement plans. Only 11% of those with incomes under $10,000, and 33% of those with incomes between $10,000 and $25,000, participate in an employer-sponsored retirement plan. By contrast, 77% of those with incomes between $50,000 and $100,000, and 76% of those with incomes over $100,000, participate in these plans. Median value of retirement assets The typical American household that owns an IRA/Keogh account has an account value of $20,000 (Table 2). The median value of an IRA/Keogh account for households with this asset increases with age and education of the householder. The median value among owners is highest for households with more than $100,000 in annual income. The typical household with an IRA/Keogh account and more than $100,000 in annual income has an IRA/Keogh account value of $70,000, compared to $20,000 or less for households with annual income below $100,000. Among households that have a defined-contribution plan through a current job, the median value of the account is $15,000. The median value increases with household annual income and education of the respondent. The typical household with a defined-contribution plan and more than $100,000 in annual income has a defined-contribution account value of $73,000, compared to $8,000 or less for households with annual income under $50,000. The median value increases with age up to age 65, when respondents are more likely to be withdrawing benefits from these accounts Adequacy of Retirement Savings Retirement savings are adequate if the resources available for spending during retirement are greater than retirement needs. The methodology employed in this analysis is based on the life cycle hypothesis and the assumption that individuals desire to smooth the level of consumption over the lifetime (Modigliani & Brumberg, 1954). This methodology was used to study both the adequacy and level of retirement savings of non-poor households using data from the 1995 Survey of Consumer Finances (Yuh, Montalto, & Hanna, 1998; Yuh, Hanna, & Montalto, 1998). The adequacy of retirement savings is evaluated at the planned retirement age the age at which the respondent indicates s/he plans to stop working full time. The sample used in the analysis is those households with a currently employed householder who provides information on the age at which s/he plans to retire. Since retirement resources are projected at the planned retirement age and retirement needs are estimated from the planned retirement age through C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 3

5 death this restriction is necessary. The households included in the adequacy analysis represent 55.1 million U.S. households (55% of all U.S. households). Approximately 33% of all householders are not currently employed (most of these householders are retired). About 12% of all householders report that s/he never plans to retire resulting in no years in retirement for which savings are needed. Methodology Retirement savings are adequate if the sum of the accumulated assets plus the present value of future pension income (including Social Security and annuities) is at least as large as the present value of retirement consumption. Adequacy of retirement savings can be expressed as: T-R T-R A R + ' B t / (1+r) t $ ' C t / (1+r) t (1) t=1 t=1 where A R = total asset accumulation at the point of retirement (age R), B t = pension income at age t, C t = consumption level at age t, R = retirement age, and T = age at death. Estimation of retirement resources. To estimate resources available for spending during retirement, the accumulation of current assets (financial assets including the value of defined contribution accounts, and nonfinancial assets including housing wealth) was projected at the point of retirement for each household using asset specific growth rates (Ibbotson Associates, 1995). The accumulated value of these assets was added to the present value of future retirement income from defined benefit plans and Social Security. Total defined benefit pension wealth was estimated from the household s self-reported information on expected benefits from defined benefit pension plans. The geometric mean of the nominal rate of return for long-term corporate bonds (Ibbotson Associates, 1995) was used as the discount rate for calculating the present value of defined benefit pension wealth. The SCF does not provide direct identification of Social Security coverage. About 95% of jobs in the U.S. are covered by Social Security. The sample in the adequacy analysis was restricted to households with a currently employed householder, so it was assumed that all households were covered by Social Security. The annual Social Security benefit was estimated using current Social Security replacement ratios based on current age, planned retirement age, current earnings, and marital status (Social Security Administration, 1998). The replacement ratio represents the portion of pre-retirement salary that Social Security income will replace. The estimated annual Social Security benefit was adjusted for early or delayed retirement as indicated by the planned retirement age. The present value of Social Security was estimated using the real discount rate applied by the Social Security Administration in their long range projections (Moore & Mitchell, 1997). C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 4

6 Estimation of retirement needs. Retirement needs were estimated with a household expenditure function that allowed consumption to vary by household income, spending behavior, life cycle stage, and housing tenure (i.e. homeowner with a mortgage, homeowner without a mortgage, renter). The household expenditure function was fitted using data from the Consumer Expenditure Survey. The Consumer Expenditure Survey is conducted by the U.S. Bureau of the Census for the Bureau of Labor Statistics (U.S. Bureau of Labor Statistics, 1999) and is the most comprehensive source of detailed information on expenditures for goods and services by households in the United States. For each household in the SCF sample, the household expenditure function was used to predict annual expenditure in the year preceding retirement. The predicted pre-retirement expenditure level was used as a proxy for the desired level of annual retirement expenditure. The household annual retirement expenditure was multiplied by the number of years spent in retirement to derive the total retirement need. The present value of total retirement needs was estimated using the real discount rate applied by the Social Security Administration in their long range projections (Moore & Mitchell, 1997). Adequacy of retirement saving. For each SCF household with a currently employed householder who provided information on the age at which h/she planned to retire, retirement resources were compared to retirement needs at the planned retirement age. If the resources projected to be available for spending during retirement were greater than the projected retirement needs, the household was classified as having adequate retirement savings; otherwise the household was classified as having inadequate retirement savings. Results on adequacy of retirement savings Only 44% of households with a currently employed householder will accumulate retirement savings that will be adequate to maintain the pre-retirement level of living throughout the retirement years (Table 3). Income is the demographic variable most closely related to the adequacy of household retirement savings. Only 27% of households with less than $10,000 in annual income, and 23% of those with income between $10,000 and $25,000, will have adequate retirement savings. By contrast, 54% of those with incomes between $50,000 and $100,000, and 69% of those with incomes over $100,000, will be able to retire with adequate savings. The percent of households with adequate retirement savings increases with age and education of the householder, is higher for households with a married householder compared to an unmarried householder, and is higher for households with non-black, non-hispanic householders compared to households with black or hispanic householders. Ownership of retirement assets increases the percent of households with adequate retirement savings. Fifty-four percent of households with retirement assets will accumulate adequate retirement savings, compared to only 17% of households that do not have retirement assets. Similar patterns are observed across the specific types of retirement assets. For nonemployer retirement plans, such as IRAs and Keoghs, 64% of households with these accounts will accumulate adequate retirement savings, compared to only 35% of households that do not have C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 5

7 these accounts. Fifty-five percent of households participating in an employer sponsored retirement plan will accumulate adequate retirement savings, while only 24% of those not in such a plan would have adequate retirement savings. With respect to defined benefit pensions, 61% of households with these pensions will accumulate adequate retirement savings, compared to only 38% of households that do not have such plans. The comparable estimates for defined contribution plans are 56% and 32%. Summary A substantial proportion of American households will not accumulate adequate resources to retire as planned. Approximately 56% of households with a currently employed householder will not accumulate adequate retirement resources to maintain their pre-retirement level of living in retirement. Household income and ownership of retirement assets have strong positive effects on the percent of households with adequate retirement savings. References Ibbotson Associates. (1995). Stocks, Bonds, Bills, and Inflation Yearbook. Chicago, IL: Ibbotson Associates. Kennickell, A. B., Starr-McCluer, M., and Surette, B. J. (2000). Recent changes in U.S. family finances: Results from the 1998 Survey of Consumer Finances, Federal Reserve Bulletin, 86(1), Modigliani, F. and Brumberg, R. (1954). Utility analysis and the consumption function: An interpretation of cross-section data. In K. Kurihara (Ed.), Post Keynesian Economics (pp ). New Brunswick, NJ: Rutgers University Press. Moore, J. F., and Mitchell, O. S. (1997). Projected retirement wealth and savings adequacy in the Health and Retirement Study. Pension Research Council Working Paper 98-1, The Wharton School of the University of Pennsylvania, Philadelphia. Social Security Adiminstration. (1998). Annual Statistical Supplement, 1998, to the Social Security Bulletin. Washington, DC: U.S. Department of Health and Human Services, Social Security Administration. U.S. Bureau of Labor Statistics. (1999). Consumer Expenditure Survey: 1997 Interview Survey CD ROM/Public Use Tape Documentation. Washington, DC: U.S. Bureau of Labor Statistics. Yuh, Y., Hanna, S., and Montalto, C. P. (1998). Mean and pessimistic projections of retirement adequacy. Financial Services Review, 7(3), Yuh, Y., Montalto, C. P., and Hanna, S. (1998). Are Americans prepared for retirement? Financial Counseling and Planning, 9(1), C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 6

8 DESCRIPTIONS OF TYPES OF RETIREMENT ASSETS Any retirement asset (excluding Social Security): includes non-employer retirement plans, employersponsored retirement plans through current job, employer-sponsored retirement plans from past jobs from which the household expects to receive retirement benefits in the future, and current receipt of retirement benefits (excluding Social Security) Non-employer retirement plan: individual retirement accounts including IRA and Keogh accounts Employer-sponsored retirement plan: any type of employer-sponsored retirement plan through current job, employer-sponsored retirement plans from past jobs from which the household expects to receive retirement benefits in the future, and current receipt of retirement benefits (excluding Social Security) Defined benefit pension: subset of Employer-sponsored retirement plan only formula type retirement plans through current job Defined contribution plan: subset of "Employer-sponsored retirement plan" only account type retirement plans through current job including 401(k), 403(b), salary reduction alternatives (SRA), thrift or savings accounts, profit sharing, stock purchase, and employee stock ownership plans (ESOP) NOTE: Families can have both defined benefit pensions and defined contribution plans. SCHEMATIC OF TYPES OF RETIREMENT ASSETS Any retirement asset (excluding Social Security) Non-employer retirement plan (IRA/Keogh) Employer-sponsored retirement plan Defined benefit pension through current job Defined contribution plan through current job (410k/403b) Retirement plans from past jobs Current receipt of retirement benefits C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 7

9 C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 8 Table 1. Percent of Households with Retirement Assets (1998) Total sample Any retirement asset (excluding Social Security) Non-employer retirement plan (IRA/Keogh) All Employer-sponsored retirement plan Defined benefit Defined contribution plan (401k/403b) pension Characteristics Employer contributes All households 100.0% 62.4% 28.3% 53.9% 17.6% 32.6% 27.0% Age of respondent less than 35 years to 44 years to 54 years to 64 years years and over Education of respondent less than high school high school graduate some college bachelor s degree graduate school Race/ethnicity of respondent White nonhispanic Black nonhispanic Hispanic Nonhispanic of other races Marital status & sex of respondent Married Unmarried female Unmarried male Total household annual income less than $10, $10,000 to $24, $25,000 to $49, $50,000 to $99, $100,000 and over Census region Northeast North Central South West SOURCE: 1998 Survey of Consumer Finances (SCF98); All statistics are calculated using the SCF final nonresponse-adjusted sampling weights (X42001)

10 C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 9 Table 2. Median Value of Selected Retirement Assets for Households with the Asset (1998) Characteristics Total sample Non-employer retirement plan (IRA/Keogh) or Employer-sponsored defined contribution plan Non-employer retirement plan (IRA/Keogh) Employer-sponsored defined contribution plan Percent with asset Median value Percent with asset Median value Percent with asset Median value All households 100.0% 49.5% $24, % $20, % $15,000 Age of respondent less than 35 years , , , to 44 years , , , to 54 years , , , to 64 years , , , years and over , , ,000 Education of respondent less than high school , , ,000 high school graduate , , ,000 some college , , ,000 bachelor s degree , , ,910 graduate school , , ,000 Race/ethnicity of respondent White nonhispanic , , ,000 Black nonhispanic , , ,700 Hispanic , , ,000 Nonhispanic of other races , , ,000 Marital status and sex of respondent Married , , ,900 Unmarried female , , ,000 Unmarried male , , ,000 Total household annual income less than $10, , , ,300 $10,000 to $24, , , ,100 $25,000 to $49, , , ,000 $50,000 to $99, , , ,000 $100,000 and over , , ,000 Census region Northeast , , ,000 North Central , , ,000 South , , ,000 West , , ,000 SOURCE: 1998 Survey of Consumer Finances (SCF98); All statistics are calculated using the SCF final nonresponse-adjusted sampling weights (X42001)

11 Table 3. Percent of Households with Adequate Retirement Savings (1998) (Only includes households with a currently employed householder who provides information on the age at which s/he plans to retire.) Characteristic Sample Percent adequate All households 100.0% 44.1% Age less than 35 years to 44 years to 54 years to 64 years years and over Education of the respondent less than high school high school graduate some college bachelor s degree graduate school Race/ethnicity of the respondent White nonhispanic Black nonhispanic Hispanic Nonhispanic of other races Marital status and sex of respondent Married Unmarried female Unmarried male Total household annual income less than $10, $10,000 to $24, $25,000 to $49, $50,000 to $99, $100,000 and over Census region Northeast North Central South West Any retirement asset (excluding Soc Sec) yes no Non-employer retirement plan (IRA/Keogh) yes no Employer sponsored retirement plan yes no Defined benefit pension yes no Defined contribution plan yes no SOURCE: 1998 Survey of Consumer Finances (SCF98); All statistics are calculated using the SCF final nonresponse-adjusted sampling weights (X42001). C. P. Montalto, Retirement Savings of American Households, April 26, 2000 page 10

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