Sorting Out Social Security Replacement Rates

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This paper estimates how much people actually receive in retirement relative to earnings before retirement when all sources of income, including income generated by homeownership, are combined. Previous studies find that middle class people need between 70 and 75 percent of their pre-retirement earnings to maintain their life style once they stop working. The objective of this study is to determine what people are actually receiving in retirement.

Regardless of how retirement income and pre-retirement income are defined, households with pensions appear to meet the threshold of adequacy. Those without pensions do not fare as well, and some must be really struggling. Taking into account a comprehensive measure of income both before and after retirement — including housing — produces replacement rates for those with pensions of 79 percent for couples and 89 percent for single person households. Those without pensions have replacement rates of 62 percent for couples and 63 percent for singles. These replacement rates drop about 15 percentage points, however, when recent earnings (the highest five years of the last ten) are used as the benchmark. The overall picture is good.

But today is in some sense the “golden age” of retirement income. Today’s retirees are claiming Social Security benefits before the extension in the retirement age to 66 and then 67, which is equivalent to an across-the-board cut in benefits. Today’s retirees also do not face the huge deductions in their Social Security check to cover Medicare premiums for Part B and Part D that tomorrow’s retirees will. And today, the average retiree does not pay personal income tax on his Social Security benefits, whereas future retirees will increasingly see a portion of their benefits subject to taxation. Finally, most of today’s retirees are covered primarily by a defined benefit plan and do not face the uncertainty associated with the inadequate lump-sum payments from 401(k) plans. The comfortable circumstances of today’s retirees make it very hard to call attention to the challenges that future retirees will face.