Replacement Rate Assumptions Could be Wishful Thinking

Although conventional planning models often use replacement rates of 70% or 85%, a new study says that the vast majority of Americans are not coming close to achieving that.
The Fidelity Research Institute’s 2007 Retirement Index found that the typical working American household will be able to replace 58% of its pre-retirement income when members stop working – a slight increase over the 2006 study result of 57%. Baby Boomers are on track to replace 62% of their pre-retirement income, and have a median of $45,000 in total household retirement savings, faring a little better than the pre-retirees, who will replace 61% of their income. Only 15% of Baby Boomers and pre-retirees are on track to replace at least 85% of pre-retirement income and 37% and 34% respectively will be able to replace at least 70%.

The Fidelity Research Institute found that working Americans, whose average age is 43, have a median of $22,500 in total household retirement savings and anticipate receiving $29,500 in annual Social Security payments. In addition, just over half (51%) of households expect to receive a pension, with a median annual pension benefit of $18,000.

In addition to personal savings, including IRAs and 401(k)s, and Social Security, which are the two most common income sources for retirement, 63% of workers say they anticipate working at least part-time in retirement (25% say their spouse will). Just over one-fifth (23%) of Americans say they plan to receive income through an inheritance, and a similar amount (21%) say they will receive income by selling their home.

Proper Planning

The awareness of the costs of health care seem to be growing, as 48% of American workers surveyed by The Fidelity Research Institute said the cost of health care will be their greatest risk when planning for retirement. Despite a growing awareness of risk in retirement, still 77% do not have a formal retirement savings plan detailing how much they need to save.

Only 23% of Americans believe they are currently saving as much as they should for retirement, but still over half (58%) predict they will have a very comfortable or somewhat comfortable lifestyle in retirement. For those workers, the Index found they should be able to generate 68% of their pre-retirement income, due largely to better saving habits. The median savings rate for these workers is 7.5% of their annual pay, compared with 3.5% for workers overall, the announcement said. Baby Boomers and pre-retirees are currently saving 4.3% and 4.1%, respectively of income. In order to replace 85% of their income, The Fidelity Research Institute sound that their savings rate should be increased to 13% for Baby Boomers and 18% for pre-retirees (and 20% and 27%, respectively, if the groups want to replace 100% of income).

When people are looking for guidance on retirement savings, they most commonly turn to a financial adviser or someone at a financial services firm (30%), but are nearly just as likely to turn to family or friends for recommendations (26%). Online calculators and planning tools and employer-provided educational materials were third and fourth, used by 22% and 20%, respectively.

Just over four in 10 (42%) workers say they improved their retirement readiness in the last six months by actions such as reallocating their retirement portfolios (25%), increasing contributions to their workplace plans (21%), and seeking guidance from a professional (20%). Of those who did not take action, they attributed this to not having enough money to save after paying basic living expenses (33%), procrastination (28%), or saying they used any extra money to pay credit card debt (27%).

In-Retirement Not Going as Planned

The Fidelity Research Institute also surveyed 793 retirees, age 55 or older, about their life in retirement compared to pre-retirement. The study found that satisfaction in retirement is strongly linked to financial comfort and good health; of those who are very or fairly financially comfortable in retirement, 64% say they are extremely or very satisfied in retirement overall (compared to 49% of retirees overall), while only 2% of those not financially comfortable agree.

Of those who find retirement to be less enjoyable than expected (26% of retirees), they say it is because of the high cost of living or financial strain (34%) or because of a disability, illness, or health problem (32%). The majority of all retirees said they regret doing some things that affected their ability to properly prepare financially for retirement, including not starting an IRA early enough (37%) and accumulating too much debt (29%).

Just over half (55%) of retires said they left the workforce earlier than planned. Of those who retired earlier than expected, 40% said that decision was a result of an illness or disability (22% of all retirees).

In planning for spending money in retirement, most retirees (82%) expected their monthly retirement expenses to mirror what they were pre-retirement (34%) or go down (48%). However, 39% of retirees said their expenses increased in retirement and just 28% said their expenses stayed the same in retirement as they were just before.

As a way to deal with the changes in expected expenses, 48% of retirees have had to make a lifestyle change, including getting a part-time job, downsizing their home, moving to a different part of the country, or reducing health care expenses either in medical visits or prescriptions.

Data for the Index is collected annually through a national online survey of more than 2,000 Americans who work full time; are 25 years or older; earn $20,000 a year or more; married/partnered with individuals who are also not yet retired; and are the financial decision-makers in their home.

The research summary report is here.