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, according to a new study by Vanguard.
Vanguard’s Retirement Outlook study used data from the Social Security Administration and other federal departments to look at the financial resources households were projected to have in retirement versus a rough estimate of their average financial needs throughout retirement. They broke the data down to study four income cohorts (low, middle, affluent and high) and three distinct generations (late baby boomers ages 61-65, Gen X ages 49 to 53 and early millennials ages 37 to 41).
The results confirm a retirement crisis among all but the highest earners.
Funding Needs
Income replacement rates in retirement are related to income during one’s working years—the more you make, the smaller a percentage of your annual income you actually need to replace to fund a retirement, according to Vanguard.
Vanguard breaks earners down into four income groups: a low-income 25th percentile income group with a $22,000 median annual income, a middle 50th percentile income group with a $42,000 median income, an affluent 70th percentile income group with a $61,000 median income, and a wealthy 95th percentile income group with a $173,000 median income.
While a 25th percentile earner needs to replace 96% of their income in retirement to cover their spending needs, an affluent 70th percentile earner only needs to replace 68% of their income, and a high earner in the 95th percentile only needs to replace 43% of their income.
“Notably, these spending-needs estimates exceed the target replacement ratios of 70% to 85% widely used in the financial services industry for lower-income families,” said the report. “Conversely, for high-income families, estimated spending needs imply a more modest retirement savings target than the industry benchmark.”
At the same time, Social Security funds a smaller portion of retirement income for higher earners—the program only funds 18% of a wealthy 95th percentile earner’s spending needs, while it will fund 46% of a 50th percentile earner’s needs and 62% of a 25th percentile earner’s needs, according to Vanguard.
The implication, Vanguard says, is that lower-earning families also need to plan to self-finance a larger portion of their retirement spending needs. 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—because of the progressive weight of Social Security’s financial assistance, according to the report.
Late Boomers In Peril
For all but the wealthiest late boomers (ages 61 to 65), who are currently entering their target-date retirement years, the picture is not encouraging. The low-income 25th percentile cohort of late baby boomers are on average able to sustainably replace 64% of their pre-retirement income using savings and Social Security, creating a retirement savings gap (the difference between their average estimated annual spending needs and their average estimated annual retirement income) of 32% of their pre-retirement income. For 50th percentile earners, an even larger 33% gap exists, while affluent 70th percentile earners still experience on average a 17% retirement savings gap.
The gap exists among these cohorts because of an 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, just 2% of pre-retirement income could be generated from their savings.
Hope For Younger Earners—With a Catch
Across early millennials age 37 to 41 and Gen Xers ages 49-53, 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, versus 53% of income for Gen Xers and 51% of income for late Baby Boomers. That’s still short of Vanguard’s estimate of 68% of pre-retirement income to cover 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 versus 52% of income for Gen Xers and 50% of income for late baby boomers—far short of the 83% of pre-retirement income Vanguard estimates that this cohort will need to spend on average annually to fund retirement spending needs.
The relatively good fortune of millennials may shift with any change. Vanguard notes uncertainty around the funding for Social Security and downside market returns as two issues that may dampen the fortunes of all three age cohorts of savers. If Social Security's funding shortfall leads to an expected 23% benefit cut in the next decade, it would take nine to 10 percentage points off the amount of pre-retirement income these groups are able to replace, the report says.
These savers—even late baby boomers in the throes of retirement--may find resilience in positive market returns, or by tapping into resources like their ability to work longer than they had originally planned, or by using home equity to fund a portion of their retirement needs, Vanguard said.