Even high earners are poised to fall behind in retirement. And for late baby boomers born between 1957 and 1962, it may be too late to catch up.
Those are the findings of a recent study from Vanguard, the world’s largest mutual fund company. The “Vanguard Retirement Outlook” used data from the Social Security Administration and other federal departments to study the financial resources households were projected to have in retirement and compared them with what these households’ rough financial needs would be. Vanguard broke the data into four cohorts (low- and middle-income, affluent and high-income people) and three distinct generations (late baby boomers, Gen Xers and early millennials).
The results show the possible retirement crisis facing all but the highest earners.
Funding Needs
Income replacement is calculated by what you made in your working years—the more you make, the smaller a percentage of your annual income you actually need to replace to fund retirement.
The four income groups included a low-income 25th percentile group with $22,000 in median annual income. The middle 50th percentile brought home $42,000, the affluent 70th percentile took home $61,000, and the wealthiest 95th percentile took home $173,000.
While a 25th percentile earner needs to replace 96% of their income in retirement to cover spending needs, an affluent 70th percentile earner needs to replace only 68%, while the highest earners must replace only 43%.
The report notes that these needs exceed the 70% to 85% targets widely used in financial services for lower-income families. “Conversely,” Vanguard says, “for high-income families, estimated spending needs imply a more modest retirement savings target than the industry benchmark.”
Social Security funds a smaller portion of retirement income for higher earners—only 18% of a wealthy 95th percentile earner’s needs, while it funds 46% of the needs for a 50th percentile earner and 62% of the needs for someone in the 25th percentile.
The implication, Vanguard says, is that lower-earning families must self-finance a larger portion of their retirement spending. With Social Security help, a 70th percentile earner must save enough to replace 28% of their pre-retirement income each year throughout retirement, but a 50th percentile earner must save to replace 37% of their income, while a 25th percentile earner must save to replace 34% of their income.
Late Boomers In Peril
For all but the wealthiest late boomers currently entering their target retirement years (those ages 61 to 65), the picture isn’t encouraging. The low-income cohort of late baby boomers are on average able to sustainably replace 64% of their pre-retirement income using savings and Social Security, but since they spend 96% of their pre-retirement income, that leaves a 32 percentage point gap between their spending needs and the sustainable replacement rate. For 50th percentile earners, the gap is even larger at 33 percentage points, while affluent 70th percentile earners experience on average a 17 percentage point gap.
The gap exists among these cohorts because of their inability to replace employment income with income derived from retirement savings, the report says. Among the 70th percentile cohort of late baby boomers, just 10% of their pre-retirement income could be sustainably generated from their private savings each year. Among the 25th percentile low earners, it’s just 2%.
Hope For Younger Earners—With A Catch
Among early millennials (those age 37 to 41) and Gen Xers (those age 49 to 53), middle and affluent earners were more likely to be on track to replace a greater portion of their retirement income.
In the affluent 70th percentile of earners, early millennials were on track to replace 66% of pre-retirement income, while Gen Xers could replace 53% and late baby boomers only 51%. That’s still short of Vanguard’s estimate of 68% of pre-retirement income for the cohort’s spending needs.
In the middle 50th percentile of earners, early millennials were on track to replace 58% of their pre-retirement income, while the number was 52% for Gen Xers and 50% for late baby boomers—far short of the 83% of pre-retirement income Vanguard estimates that these cohorts will need.
Fortunes may also shift if markets fall or Social Security is cut. A 23% benefit cut in the next decade would take nine to 10 percentage points off the amount of pre-retirement income these groups are able to replace, Vanguard says.