Measuring Retirement Income Adequacy Not An Exact Science

The Congressional Budget Office (CBO) has issued a report explaining the various measures and approaches to measuring retirement income adequacy, providing a framework for further analysis of retirement income.

The report explains that researchers have developed diverse approaches for quantifying the adequacy of retirement income, focusing on different groups of retirees and employing different definitions of income and adequacy. For example, some researchers have computed the fraction of current retired workers whose income is below the poverty threshold and found it to be less than one-tenth of retirees. In contrast, others who have examined how income changes upon retirement project that a much larger fraction of current workers would experience a substantial decline in income as they retire.

Researchers have defined the adequacy of retirement income in two main ways: whether it satisfies basic needs and whether it allows retirees to maintain the standard of living they experienced before retirement. The CBO notes that economists and financial advisers generally use the second definition because large drops in consumption in retirement are typically considered undesirable.

The most widely used measure of the adequacy of retirement income—a threshold based on the standard-of-living definition—is known as the target replacement rate. That rate is broadly defined as the amount of income in retirement, expressed as a percentage of income before retirement, that enables retirees to maintain the standard of living they enjoyed while working. Although a common rule of thumb is that replacing at least 70% of gross preretirement income would avoid a marked decline in retirees’ standard of living, the CBO says that specific goal is not appropriate for all people. To better capture the diversity of people’s circumstances, researchers have developed a range of target rates that vary with individual characteristics, such as marital status, lifetime income, and homeownership.

Without the ability to adjust factors used in replacement rate planning tools, workers may over- or under-estimate how much they need to save for retirement, the Government Accountability Office (GAO) concluded in a report.

Current measures of the adequacy of retirement income provide diverse answers about the state of retirement income security in the United States. That diversity stems from a number of sources. One source is which definition of adequacy is used (meeting basic needs or maintaining the preretirement standard of living). Other sources include which cohorts are analyzed and precisely how income and wealth are counted.

In general, researchers conclude that fewer than one-tenth of retirees will have income below the lowest basic needs threshold—the poverty threshold—while a much larger fraction of people are projected to have income that will fall short of maintaining their preretirement standard of living. For example, in one study, the authors projected that only about 6% of workers in their 40s and 50s would have future retirement income below the poverty threshold. In contrast, recent analysis using the National Retirement Risk Index (NRRI), a measure developed by the Center for Retirement Research at Boston College, indicated that about half of working-age U.S. households were “at risk” of not being able to maintain their living standard in retirement.

Even when the thresholds are based on the same broad definition of adequate income, the CBO says, researchers have made different analytical choices when constructing the adequacy measures, resulting in different findings. For example, in contrast with basic needs studies that rely on the poverty threshold, a recent analysis using the Elder Economic Security Standard Index, or the Elder Index—which is a basic needs threshold based on the larger expenses that are common among households with elderly members—found that about one-quarter of two-person households whose members were age 65 or older and more than half of the elderly people in single-person households would have inadequate income.

Similarly, according to a recent literature review by the Government Accountability Office (GAO), studies that evaluated the extent to which workers were able to maintain their preretirement living standards reached a broad range of conclusions. Overall, across the studies, the share of current workers who were at risk of having inadequate income ranged from about one-third to two-thirds.

Improving the Measurement of Retirement Income Adequacy 

Although a number of factors cause conclusions about the adequacy of retirement income to diverge, the CBO notes that recent research delves further into the role of data quality, examining differences between publicly available survey data and restricted-use administrative data. (Administrative data are collected for administrative purposes by governmental agencies, such as the Internal Revenue Service or the Social Security Administration.) The vast majority of studies on the adequacy of retirement income use self-reported data because that information is widely available. However, income is known to be underreported in surveys, particularly income from employer-sponsored pensions and other retirement accounts.

The report concludes that ongoing research is seeking to improve current understanding of the extent and nature of underreporting and to clarify how underreporting could affect conclusions about retirement adequacy.