Andrew Biggs has been saying for years that there is no retirement savings “crisis”—and his latest research takes aim at what he says are flawed income replacement rate calculations from the Social Security Administration that are contributing to a perceived problem.
Americans approaching retirement are regularly told they won’t have a sufficient retirement income to maintain their standard of living once they leave the workforce. That’s not necessarily the case, Biggs argues in a new working paper released this week by the American Enterprise Institute, a Washington, D.C.-based think tank where the former deputy commissioner of the Social Security Administration is a senior fellow.
The paper, “Replacement Rates and the Retirement Crisis,” posits that the SSA is doing Americans a great disservice by officially saying Social Security will replace 40% of their pre-retirement income, while the ideal proportion for people to maintain a decent standard of living, it says, is 70%.
The paper says the methodology used to reach that 40% figure is flawed. With the income “replacement rate” being one of the most important measures of how retirees are faring, it needs to be accurately represented—and it’s currently not being done.
“SSA’s replacement rate method significantly exaggerates the real purchasing power of worker’s earnings, by crediting workers with earnings they never had. This in turn makes their Social Security replacement rates appear smaller.”
Andrew Biggs
“A Social Security replacement rate divides benefits at retirement by a worker’s pre-retirement earnings. For instance, comparing Social Security benefits to the inflation-adjusted average of pre-retirement earnings would make sense,” Biggs told 401(k) Specialist. “But the SSA’s replacement rate method significantly exaggerates the real purchasing power of worker’s earnings, by crediting workers with earnings they never had. This in turn makes their Social Security replacement rates appear smaller.”
For instance, Biggs added that a medium wage worker retiring at the full retirement age in 2023 receives an annual Social Security benefit of $28,204. The Social Security Trustees Report claims that this benefit replaces 42.6% of the medium wage worker’s career-average earnings. This implies that this worker had career-average annual earnings of $66,147 (i.e., $28,204/0.426 = $66,147).
“But here’s the problem: these claimed earnings that a new retiree received over the last three to four decades are actually higher than the average wage of workers today. This is despite the fact that national average wages have increased by 17% above inflation over the past 20 years and by 45% in real terms over the past 40 years,” Biggs said.
A logical way to calculate a Social Security replacement rate, Biggs said, would compare Social Security benefit to the inflation-adjusted average of a worker’s pre-retirement earnings. That compares the purchasing power of their Social Security benefit to the average purchasing power of their salary over their career.
“If we do this for an average-wage worker, Social Security benefits replace about 54% of their pre-retirement earnings,” he said. “If that person is aiming for a total retirement income replacement rate of 70%, as the SSA says that most financial planners recommend, Social Security benefits alone take them about three-quarters of the way there.”
Biggs writes that SSA replacement rate methodology is causing the future of retirement security to appear worse than the present, precipitating fears that Americans face a “retirement crisis” of inadequate incomes in old age.
The working paper concludes by saying SSA’s projections of a significant decline in median retirement income replacement rates and increase in the share of seniors with low replacement rates is entirely driven by the assumption that seniors desire an income that rises along with national average wages—or “keeping up with the Joneses.” The paper shows why he believes this assumption is incorrect.
“If retirees are instead assumed to desire an income that allows for a similar standard of living of living that they enjoyed prior to retirement, a standard that is more consistent with financial planning and the life cycle hypothesis in economics, retirement income adequacy is found to improve in future decades.”
Bottom line: Despite what he says is the SSA’s flawed approach to calculating replacement rates, retirement income security is improving rather than declining.
Read the working paper here.
SEE ALSO:
• So Far, Retirement Crisis is a ‘No-Show’: Andrew Biggs
• Chris Christie: Politicians ‘Liars and Cowards’ for Not Addressing Social Security Crisis
• Is There Really a Retirement Crisis?
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
Biggs is massively overthinking this.
Best to work with the client to find out what income they NEED to cover their non-discretionary spending plus inflation, then find out what income they WANT so they can live out their values for the rest of their lives. Who cares what percentage SSA says they cover? That’s just a statistical number, with no relevance to what the client is actually looking for.
Numbers are just numbers. We work with real people. Let them decide what they want the rest of their life to look like.