While I’m on the subject of Social Security, I’m working on a post in which I try to model what it would take for an average income earner to save enough so that they received 60% of their wages in retirement income. I think it’s obvious that it’s, at the very least, impractical absent Social Security retirement income, and that those who advocate some variation on an expanded version of individual retirement accounts as an alternative haven’t really thought it through. But there’s quite a bit of ongoing disagreement on the subject so I think it’s worth a little chalktalk to look at the numbers.
I can’t imagine this hasn’t been done before. If anybody knows of a study or a model of this, I’d appreciate hearing about it. It’s sort of a lot of work for a casual, amateur blogger to tackle.
In the final analysis I think that social policies (like social insurance) are both practical and aspirational. They’re constrained by what will work and the realities of the economy we have but they’re also informed by the society and economy we’d like to have as well.
At the very least an America without Social Security retirement income will be one in which savings is signficiantly higher and personal consumption expenditures dramatically lower than they are now. IMO some change in that direction would be an improvement but the numbers matter. I’m not sure we can tolerate that large a decline in PCE.
I did some quick calculation using one of the many available online retirement calculators (I used this one which is handy since you can turn social security on or off). A lot depends, obviously, on assumptions. After 15 minutes of playing around, it looks like for someone with a median income (~$45k) retiring at 65 would need to save between 10 and 20% of income annually (depending on assumptions) from 25 onward to get 20 years of income at 60% of their wages. That’s without social security. With social security you’d have to save about half that. That’s using conservative rates-of return – 5% before retirement and 3% after.
I believe CBPP has done this. I will look later, if call is slow. I would modify your assumptions just a bit. At the lower end of the income ladder, 60% of wages will hardly be livable. Saving an extra 20% will make wages unlivable for some.
Steve
Just did another run – a semi-worst case scenario. Assumptions: The rate-of-return on saving and income only keeps pace with inflation and there is no social security. With those assumptions, you’d need to save 33% of income to have an income of $27k a year (60% of the median income of $45k) for 20 years from 65-85. With social security you’d need to save 10% of income.
That site’s a good start, Andy. Thanks. My quick noodling around suggests that it’s impossible at median income.
Here are the assumptions:
1. You’ve got to assume passbook savings rates. Otherwise there’s risk involved. If some sizeable proportion of people can lose all of their savings and you don’t allow these people to be destitute, you’ll end up creating another program that does what Social Security does, it just won’t be called Social Security. I don’t see that as an advantage.
2. You’ve got to work from after tax income. No Social Security in this scenario but there are still taxes.
3. Further, assume $10,000 per year in rent (you’ll never buy a house at this income level under these circumstances) and $10,000 per year in healthcare insurance. For a family of four in Chicago that’s pretty entry level. Add the bare minimum (so to speak) for food, clothing, and utilities and there isn’t much left over to save.
And we haven’t even started addressing the economic disruption issue. An economy in which 80% of the people have a 20 or 30% savings rate has a lot less personal consumption than one that has no savings.
You also need to make it very difficult for people to get money out of their retirement fund if you go this route. People now change jobs much more frequently. They undergo periods of unemployment much more frequently. They also need to save for that possibility.
Steve
Dave, why would you assume (2) taxed retirement savings? Currently, we have SS and tax-deferral devices; I would assume the most likely alternative scenario without SS would be some forms of IRAs, perhaps with higher contribution limits.
I haven’t run any numbers for a median wage-earner, but permit me to make an obvious observation:
A median wage earner can quite easily save enough to provide 60% of income for 1 day of life following retirement. He can also quite easily save enough to provide 60% of income for 1 year. 5 years is probably more challenging. 10 years even moreso. Perhaps it is correct that 20 years is unattainable.
But what this illustrates is that the more relevant calculation is the tradeoff between years of retirement and desired spending after retirement. The problem is the ridiculous assumption that workers should retire at age 65 or at age 70, and live off of investments for 20 years.
I didn’t express myself accurately enough and, yes, that’s an additional complication. The amount available for saving is only a percentage of pre-retirement after tax income.
Absolutely, sam. That’s exactly my point. Again, repeating the point I made in the body of my post, we need to think about what we want our society to be like, recognizing the constraints, and tailor our policies to the ends we’d like to accomplish.
I’ve already expressed my preference for a later SSRA and for more means-testing. We already do some degree of means-testing—it’s built into the benefit formula. That’s condemned by some, progressives in particular, as unfair and inhumane.
Conservatives, on the other hand, point to an expanded IRA model which I think is clearly unworkable. It’s either self-defeating or it doesn’t accomplish the objective.
That’s why I think that our preferred solution should be tweaking FICA max, minimum SSRA, normal SSRA, and the formula for cost of living adjustments.
sam, that’s not entirely an obvoius point. Most people take the reduced benefits from early retirement from SS. Either (a) they were able to save sufficiently during their lifetime that full SS benefits were not necessary or (b) they’ve made a bad bet. Retirement planners tell me its (b), but how do we know?
(The recession suggests option (c) unemployment. But I’m looking at pre-recession figures showing 58-64% take early retirement as opposed to 72-75% in 2009)
Yeah, I agree Dave, it’s not at all practical for medium income earners, much less those with low incomes. Hell, my current savings rate is about 25% on ~80k in income which is, of course, manageable but requires a lot of discipline with 3 kids and it does help that my effective tax rates are very low. Tax rates are going to go up – they have to – and that’s another factor that’s going to impact what people can put away.
I agree on your preferred solution, but of course social security doesn’t exist in a vacuum. As I recall, Ireland and a couple of other countries essentially raided their pension programs in response to their economic crises. It’s hard to imagine that Congress would do something similar, but you never know.
Forced savings in Singapore seems pretty successful.
We save 25% or more every month (though some of that is kids college), are aiming for 50% of income in retirement and are assuming no SS. We are comfortably in the highest income quintile and have never owned a new car, will likely never own an rv or a boat, and overall stick to a very modest budget.
If they take away my SS to give it to someone who made the same income but bought boats and rvs I’m going to be really ticked.
The arithmetic is EZ, the assumptions harder. Sorry to be cryptic, gotta catch a plane.
Later.
Not cryptic, just true. Just because the stock market has gone up in the past, can we assume it will go up, and at the same rate as in the past? What if the GOP passes its version of Medicare? Will 60% be enough?
Steve
OHare has blessed me with a landing.
OK, people. Rule of 72. Any combo of rate and years multiplied to get 72 doubles principal.
But what is a REAL rate?? Trouble.
What is the risk adjusted rate? Trouble.
The original question was how to get 60% of your pre-retirement income. OK.
To scale it: $100K current income. Bogey: $60K retirement.
First cut: 4% yield, you need $1.5MM. Is 4% real? Probably not. That’s why QE is so corrosive. Don’t blame me. Blame Obammy and Bernanke.
Second cut. You can deplete principal. 25 years? (Let’s hope!!) That depletes the $1.5MM by $60K per year. Of course the yield comes down because the basis comes down. And no pass along to the kiddies or charity.
Everyone has their own version of what is appropriate retirement income. But just with this you can do your own math. Just remember: REAL income vs NOMINAL income. Depletion of the base. And accurate estimation of depletion (a fancy way of saying “when I die I have this much left, and what I want to leave)”
Lastly, never forget the “perpetual motion machine” approach – say, basis of $15MM x 4% = $600K per year in perpetuity. Sounds cool, eh?? Ooops. But if “personal inflation” is 5% per year, then your basis is declining by $750K/yr. That means your nest egg is gone in about 20-25 years. Don’t ever discount the wickedness of government, and inflation.
So you would prefer the inflation rates we had under Bush?
Steve
Its just arithmetic, steve. Just arithmetic. And contrary to the all out – perhaps alcohol induced – assault on my character by Reynolds over at OTB, the steely eyed analyst in me looks at government policy no matter the current incumbent and asks: how does this affect the Average Joe? And almost always its adversely.
As best I can tell, the problem people have with me and my views are 4: 1) I already pay an enormous amount in taxes, and give an enormous amount to charitable causes – so I want a boundary condition; but it never seems to be enough for lefties, 2) exceeding that boundary condition has negative effects on taxable revenue and job creation – not good for the AJ, 3) I don’t believe the majority of taxes actually go to help the AJ – its a scam for politicians, always thinly cloaked in do-gooderism. Most of the money is siphoned off., 4) attributed to Lincoln, although probably apocryphal – “you can’t help the poor by hurting the rich.” And that’s the real motivation of so many on the left. See point 3.
Drew,
Well, no. The problem I have with you is that you are quick to jump on people and call them liars and other names when they disagree with you or are trying to get you to support some of your claims. You shouldn’t be surprised when people are hostile when you so casually impugn their integrity.
Well, Andy, I would dispute that assertion. But I’ll try to do better. A blunt approach to debate is in my nature, and I don’t suffer trafficing in erroneous data or weird arguments well. A weak kneed diplomat I will never be.
If you go over to OTB and two threads you will discover that I am perhaps the worst person in the world, according to a certain M. Reynolds. Bummer. I spend most of my time here and at OTB on the topics of taxation, government finance policy and promotion of business activity because it basically is and has been my business for 20 some years, and I know it like the back of my hand. What fascinates me is that – and I make this point for the umpteenth time -those who may be tremendously talented in their own fields feel free to weigh in, embarrassingly light at times, on things they know nothing about – showing no consideration for – if I may say so – a rather successful practioner in the field. Yet I have never, ever strayed into telling peoiple how to write books, write computer code etc beyong my expertise or experience. (One exception – global warming. And yet I understand the underlying science perhaps better than 90% of commenters, and the theory is crumbling by the day.) Its called wisdom. You might want to think about that.
@Drew- If it is just arithmetic, and most of it is, then surely you are aware that inflation was higher during the prior administration. IIRC, you are influenced by the CHicago school, so you probably think markets are correct (feel free to correct this). Bond rates are down. The have been down. There is no clear indication of expected inflation, other than from inflation hawks. While I respect your analytical ability, I think that personal bias affects everyone. I see it in my profession where many/most docs think they have nothing to do with high medical costs. I think it affects business people also.
Steve
If you are going to look at this problem, you need to tackle this issue of endogeneity. That is, since Social Security already exists you cannot look at current retirement savings rates and draw any conclusions, at least not without some extra work involved. Without that extra work you really aren’t going to get a meaningful answer.
Also, depending on labor market conditions, that for most people Social Security gobbles up 6.2-12.4% of their pre-tax income. Right there we get halfway to the 25% number Dave finally ends up with in his later post.
steve –
First, I was taking a long term, multi-administration view on inflation. But you obviously have a political point you want to to make: Bush vs now. Me: no.
So to your point – You are speaking about headline inflation, and have failed to acknowledge the dominance of housing in the quoted stat. But if you own a home your costs are fixed wrt financing or buying. Its all the other basket of goods that matters; that’s what you and your wife go out and buy. Energy, food, healthcare, insurance etc. And their rates are very high. read the papers.
This shouldn’t be a controversial point.
PS –
bond rates are down a/c quantitative easing and flight to quality/safety. Don’t confuse that with goods prices.