The Retirement Dilemma: Keep Working?
As the first cohort of the baby boom generation this year hits 63—which is the average age of retirement in the U.S.—the big question is: Are they financially ready to retire? That question is only going to gain urgency in the next several years as more and more boomers jump into the pool of retired Americans. Unfortunately, statistics suggest that retirement isn't going to be nearly as comfortable as most boomers had hoped. Declining wealth, brought about by lower stock prices and falling home values, has hurt older households substantially. Americans lost 18% of their net worth last year, and the decline has disproportionately hit households of those nearing retirement. But even before the asset bubble burst, Americans looked ill-prepared for retirement. A year later the situation is no better. The Center for Retirement Research (CRR) at Boston College estimates that 43% of Americans are "at risk," meaning they would be unable to maintain their current standard of living in retirement. The good news: Most Americans seem to understand their situation. Only 19% of the population says they are prepared when they really aren't, according to a CRR survey. The bad news is that they don't seem to be doing much about it, whether through saving, paying off debt, or taking advantage of preretirement investment opportunities available to them. Simply put, many Americans are not financially prepared to stop working because of a variety of issues. Many households have no real retirement plan, period. The average American family has not saved enough to retire and maintain the standard of living they've enjoyed in previous years. Moreover, at a time when they should be free of burdens such as mortgages, many pre-retirement households still have a high level of debt when they should be planning for reduced earnings. Watching their retirement savings dwindle or fretting about looming layoffs, workers now have far less confidence that they'll have sufficient funds for their golden years than they did in 2007, according to the Retirement Confidence Survey done in April 2009 by the Employee Benefits Re?search Institute and Matthew Greenwald & Associates.
will social security and medicare hold upHistorically, most Americans have relied on government programs to fund their retirement, but they're also losing confidence in this option, according to the survey. With good reason: The financial vulnerability of those set to retire soon is matched by increasing cracks in that foundation. New projections for federal entitlements such as Social Security and Medicare indicate that both will run out of money sooner than expected—well within the lifetimes of most boomers.
It's probably too late to do much for the first wave of boomer retirees—they're already too close to retirement. Even most younger Americans will have to rethink their retirement strategies because no magic cure exists. The solution may lie in a combination of actions such as raising the age to collect full Social Security benefits and Medicare to be more in line with longer life spans, working beyond retirement, and aggressively cutting debt.
Alicia Munnell and Steven Sass put a likely answer to this problem right in the title of their recent book, Working Longer: The Solution to the Retirement Income Challenge, (Brookings Institution, Washington, D.C., 2008). Two years ago the average American expected to retire at age 63. Now it's 65, according to the Retirement Confidence Survey. But it's unclear if all workers will actually work that long, since the same survey also showed that 47% of retirees stopped working "earlier than planned."
For quite some time, Americans have not had enough savings to finance retirement, but a look at total financial assets shows the situation has worsened. At the end of 2007 the median household in the 55-to-64 age group had total financial assets of only $72,400 according to the 2007 Survey of Consumer Finances (SCF), which the Federal Reserve does every three years. Based on the performance of financial markets over the last year, that number is probably now down to $55,000. a vast wealth gapThe SCF gives little reason for optimism. Even in the pre-retirement age group (ages 55-64), only 58.4% of families saved any money last year, just slightly above the national 56.5% ratio. Median net worth was $253,700 for this cohort, but most of that is tied up in the family home, which declined in value this year and in any case is not a very liquid asset. These households are richer than the national median of $120,300, but they're not rich enough to live in comfort for 20 years of expected retirement.
While measures of wealth show pre-retirees are better off than younger Americans, disparities among different subgroups have risen. The average level of wealth is much higher than the median, at $935,800 for the 55-to-64 group and $556,300 for the nation. The top wealth owners are in relatively good shape, but most of the population isn't rich or even adequately financed. Wealth is concentrated in the top 10% of households, which had a net worth averaging $4 million in 2007. Net worth is much less evenly distributed than income. The ratio of the income of the 95th percentile to the median, a standard measure of inequality, is 4.4. The equivalent wealth ratio is 15.7.
Of course, part of the reason for the inequality is that wealth tends to increase over time. Older households have more money than younger households because they have had time to accumulate wealth and pay down mortgage and other debt. While households in the 55-to-64 bracket have only 115% of median income, they have 199% of median net worth. The ratio of their net worth to the national median has gone up in recent years. In 1998 it was only 178%. In our view, the growth of defined-contribution accounts, such as IRAs and 401(k)s, probably explains most of the increase.
At the other extreme, the high percentage of families without any pension or retirement savings is a concern. This percentage has declined over the period for which the Fed has been doing the SCF surveys, but currently 42.3% of all households have no pension or other retirement savings, such as a 401(k) or IRA. For those who have coverage, 55.8% have a defined-benefit plan (37% of the total number of households), while 65.8% have a defined-contribution account (21.6% have both). The median value of these accounts was $45,000, but it was $98,000 for households in the 55-to-64 age bracket. (The median is only for the 57.7% of the population having such accounts.)
the old rule: debt-free at retirementNot everyone with access to such a plan makes use of it. In 2007 only 83.8% of family heads with access to a defined-contribution account participated (down slightly from 84.1% in 2004). Participation is tied closely to income and was much lower for eligible households in the bottom two quintiles (45.7% and 71.9%), while 91.3% of those eligible in the top quintile participated.
Of course, even $98,000 is too little for retirement. The rule of thumb is that a new retiree (age: mid-60s) can afford to take out only 4% of the asset balance each year to support consumption—and $4,000 a year doesn't go very far in today's world.
A big problem is that pre-retiree households are increasingly saddled with debt at a time in people's lives when they should be reducing their living costs. The old rule was that all debts should be paid by retirement. Financial institutions designed a 30-year mortgage, in part, to be paid off by age 65. But the 2007 SCF found that 81.8% of households in the 55-to-64 age bracket and 65.5% of those in the 65-to-74 age bracket still had outstanding debt.
The older you are, the more likely you are to own a home. This is important in retirement, since owning your own home can provide liquidity through a reverse mortgage or sale (especially if you move to an assisted-care facility) and will generally cut your cost of living, particularly if you have paid off the mortgage. Unfortunately, many haven't. For households in the 55-to-64 bracket, 55.3% have mortgages, compared with a national ratio of 48.7%. Homeownership rates also continue to increase with age even after retirement. Those in the 65-to-74 bracket have an 81.3% homeownership rate, and for those 75 and up, 85.2%. The median mortgage in the 55-to-64 age bracket is $85,000, compared with a median home value of $219,700.
Retirees' debt loads also differ from those of working households. As might be expected, retirees are less likely to have debt, with only 52.3% having any and only 27% with a mortgage on their primary residence (vs. 48.7% overall). The median debt for retired households is $20,000, well below the national median of $67,300. Retirees have median net worth of $161,300, vs. $120,300 overall.