Is America on the brink of a retirement disaster? Baby boomers are chugging their way toward retirement and many see a train wreck ahead. So how bad is it?
Answering these questions depends a bit on optimism or pessimism about the future. You can count me on the pessimistic side, but that doesn't mean I'm pessimistic about all boomers. I'm just pessimistic about the ones who are probably least likely to see a financial advisor.
America is in the midst of a brave new experiment in self-funded retirement income. Well, sort of. In Social Security, we still have the largest forced annuitization program in the world. Beyond Social Security, however, we're relying on individuals to create their own retirement security.
The share of near retirees with defined contribution (DC) assets rose from 12% in 1983 to over 60% today. Despite the majority having DC assets, only 31% of workers were participating in DC plans in 2008. One of the most striking facts of the defined contribution era is the disparity between haves and have-nots. A pension system forces everyone to save for retirement and then replaces a significant share of their income. Add on Social Security, and there aren't many have-nots among those who also have a generous employer pension.
A DC system forces workers to choose how much to save and how to invest. Some save more, some don't save enough, and a lot of workers don't save anything. According to 2010 Fed data, about 45% of American workers aren't currently saving for retirement.
In actual numbers from the Employment Benefit Research Institute, the median employee in the top 10% of wealth has about $200,000 saved for retirement compared to $22,000 for a middle class employee. The median worker with an income over $100,000 has saved about $100,000, but the average is $360,000. That means that there are some higher-income workers who are saving a lot, but most workers aren't saving enough. In fact, only 64% of workers between the age of 55 and 64 have saved an amount equal to one year of income.
Now let's not get too overly sentimental about the old pension era days. In 1980, the proportion of American workers who participated in a defined benefit pension plan was only 38%, according to the Social Security Administration. That meant the rest had to fend for themselves in a world without organized employer-sponsored DC savings plans.
The majority retired with a pension, but that pension wasn't always substantial for workers who changed jobs over time. We shouldn't fall victim to pension nostalgia — Social Security has been, and will continue to be, the foundation of retirement income for the elderly (it is currently 39% of total income for those 65 and older).
Disparate Impact
Ironically, boomers in the bottom quintile of lifetime income are far less likely to have a defined benefit (DB) pension (25%) versus boomers in the top income quintile (58%). Mix this disparity in pension income with a disparity in DC assets and you can begin to see where the crisis is going to hit.
There are really two groups who appear most vulnerable. The first are private sector lower middle class workers who may have benefited from union-negotiated pensions (rates of union membership have dropped by 45% since 1980). Compared to public sector working class employees, who are far more likely to receive a pension, today's less educated private sector worker often arrives at retirement with little savings.
The second group is higher-income private sector workers who simply do not save enough. Although middle class workers have saved much less, they are able to replace a much larger share of their income with Social Security. Higher-income workers who haven't saved a significant amount are likely to experience a much larger drop in spending at retirement.
A recent study by the National Institute on Retirement Security finds that only a quarter of workers in the lowest income quartile even have a retirement account versus 90% in the highest quartile. Owners of a retirement account have between five and seven times the non-retirement wealth of those who don't own a retirement account within the same age group. This means that those with the most non-retirement wealth also have the most retirement wealth. By far.
One of the reasons lower-income boomers are so unprepared for retirement isn't because they are irresponsible. It's because our DC system provides a much greater retirement saving incentive to higher-income workers. In a chronically underappreciated 2003 study, Boston University professor Laurence Kotlikoff and Cato Institute senior fellow Jagadeesh Gokhale measured the relative benefits that the defined contribution system provides workers at different income levels.
