1. Alternative Measures of Replacement Rates Michael D. Hurd RAND and NBER Susann Rohwedder RAND We gratefully acknowledge research support from the Social Security Administration via the Michigan Retirement Research Center, and additional support from the National Institute on Aging.

2. 2 Adequacy of resources in retirement Focus of considerable research Need to put in relationship to resources available during lifetime. How to assess those resources?

3. 3 1. Income replacement rate Pre-retirement income a proxy for lifetime income Complete replacement of income Fraction such as 80 percent But: no systematic accounting of - taxes - financing consumption out of savings; - the time horizon or survival curve of the household; - returns to scale in consumption: “need” of couple changes at death of a spouse. - the changing consumption profile with age;

4. 4 How to assess adequacy? 2. Estimate lifetime income. Compare accumulated wealth with “optimal” wealth Hard to do 3. Can resources at retirement maintain consumption? or consumption path… consumption not necessarily constant

5. 5 - Observe someone at 65 consuming at some initial level - Have theoretically or empirically derived consumption path - Ask: can resources support that path? Examples Our Method

6. 6 (Exactly) Affordable Consumption Path

7. 7 Consumption path that leaves excess wealth

8. 8 Consumption Path not Affordable: Under-saving

9. 9 Consumption and Activities Mail Survey (CAMS) October, 2001, CAMS wave 1 5,000 HRS households (random selection) Couples: one of two spouses at random. 3,866 returned questionnaires: unit response rate of 77.3 percent. Low rate of item nonresponse Spending measure close to spending in Consumer Expenditure Survey October, 2003, CAMS wave 1 Sent to same households Substantially same as CAMS wave 1 Use change in consumption to generate life-cycle paths

10. 10 Real spending (thousands) by singles and percent change over two years, panel AgeWave 1Wave 2% change 65-6925.625.5-0.28 70-7426.327.11.48 75-7924.824.5-0.55 80-8428.122.2-11.77 85 +28.323.8-8.66 Age 65 consumption = 100 Age 66 consumption = 100*(1-.0028/2) Age 67 consumption = (Age 66 cons.)*(1-.0028/2)

11. 11 Comparison of empirical consumption path to model CAMS actual wealth change similar to model

12. 12 Comparison of empirical consumption path to model CAMS has flatter consumption path relative to model; but not much survival past 85.

13. 13 Add data from Health and Retirement Study core Waves 2000, 2002 & 2004 - work status - wealth - Social Security and pension income

14. 14 Choice of sample Want: Observe all resources bequeathable wealth Social Security Pension income (Future earnings) Singles 66-69, N = 210 Couples 66-69, not working, and spouse 62 or older N = 282.

15. 15 Initial conditions : Couples 66-69 Couples, thousands 2004$ PercentileConsumption Total annuity Excess spendingWealth 10%18.012.8-5.214.9 25%23.619.4-4.283.5 50%33.727.9-5.8262.8 75%50.042.1-7.9669.0 90%69.358.2-11.11154.1 Mean40.832.8-8.0525.1 At mean, spending $8,000 more than income, but $525 thousand in wealth.

16. 16 Initial conditions : Couples 66-69 Couples, thousands 2004$ PercentileConsumption Total annuity Excess spendingWealth 10%18.012.8-5.214.9 25%23.619.4-4.283.5 50%33.727.9-5.8262.8 75%50.042.1-7.9669.0 90%69.358.2-11.11154.1 Mean40.832.8-8.0525.1 At median spending $6,000 more than income But $263 thousand in wealth

17. 17 Initial conditions : Singles Singles, thousands 2004$ Percentile Consump- tion Total annuity Excess spendingWealth 10%10.34.7-5.60.0 25%14.57.6-6.94.0 50%21.611.0-10.555.8 75%29.716.9-12.8235.6 90%42.625.4-17.3568.6 Mean25.814.3-11.4183.9 Even at mean wealth barely adequate. Can support about 15 years of spending. But not at median.

18. 18 Simulations from initial conditions Singles Begin with observed consumption Follow consumption path of singles Real annuities (Social Security) and nominal annuities (pension income) Random mortality from life-table. Importance: don’t need resources to last forever Example…

19. 19 Overspending if live until 83, but might die before 83.

20. 20 We measure “Excess” Wealth By how much did initial bequeathable wealth exceed necessary wealth? Necessary wealth: amount needed to follow CAMS consumption path - Simulate 10 consumption paths for each person. - Find probability of outliving resources - Find “excess” wealth Same as present value of end-of-life wealth

21. 21 Singles, thousands 2004$ MeanMedianMean 40-60 pctl. Initial wealth 183.955.856.0 Present value annuities 159.4127.3120.6 Total resources 343.3205.8176.6 Present value consumption 279.8224.0167.6 Excess wealth 63.55.79.1 At mean singles can afford consumption path. Also at median.

22. 22 Singles, thousands 2004$ MeanMedianMean 40-60 pctl. Initial wealth 183.955.856.0 Present value annuities 159.4127.3120.6 Total resources 343.3205.8176.6 Present value consumption 279.8224.0167.6 Excess wealth 63.55.79.1 Mean among those in 40-60 th percentile of excess wealth Consumption $9,000 less than resources But those in lower part of distribution cannot afford path.

23. 23 Couples Begin with observed consumption by a couple. Follow consumption path of couples as long as both alive At widowing Reduce consumption according to returns to scale Reduce annuities by 1/3 (as is typical with Social Security ) Then follow singles’ path Example. Returns-to-scale: poverty line. Single needs 0.79 of consumption by couple

24. 24 (Exactly) Affordable Path

25. 25 Consumption Path not Affordable: Under-saving

26. 26 Couples, thousands 2004$ MeanMedianMean 40-60 Initial wealth 530.1262.8291.5 Present value annuities 312.9268.6308.6 Total resources 843.0631.6600.1 Present value consumption 408.2326.8351.5 Excess wealth 434.8244.3248.7 At mean and median substantial excess wealth.

27. 27 Summary so far: At population level (mean or median) couples have adequate resources; also singles (barely). What about distribution? Problem of measurement error in income, wealth and consumption. With classical measurement error Negative observation error on wealth and/or income; Positive observation error on consumption Either or both => Under-saving (possibly falsely)

28. 28 Group by characteristics such as education

29. 29 Singles. Thousands of 2004$ Present value NwealthannuitiesCons’n Less than high school5840.1107.5225.1 High school83170.0158.2267.7 Some college45285.3169.8303.0 College +24388.9269.7410.2 All210183.9159.4279.8 Less educated begin with much less wealth; lower annuities and lower consumption

30. 30 Singles. Excess wealth (2004$ thousands) and percent with positive N% positiveMeanMedian Less than high- school5837.6-77.5-29.6 High-school8352.260.56.1 Some college4560.9152.145.9 College +2468.8248.480.2 All21051.963.515.0 Sharp variation by education level. Less educated will have to reduce consumption Systematic variation despite measurement error

31. 31 Less educated begin with much less wealth; lower annuities and lower consumption Couples. Thousands of 2004$ Present value N wealth annuitiesCons’n Less than high school61296.0208.1305.9 High school118416.5320.4384.2 Some college47531.8349.2436.4 College and above561022.9381.0546.6 All282530.1312.9408.2

32. 32 Couples. Excess wealth (2004$ thousands) and percent with positive N% positivemeanmedian Less than high- school6167.5198.377.4 High-school11881.3352.7240.7 Some college4779.1444.6289.5 College and above5683.2857.3519.8 All28278.3434.8244.3 But even among least educated, mean and median excess wealth positive. College and above “over-saved.”

33. 33 Still to be done Differential mortality: Poor tend to die earlier than well-to-do. Will reduce difference between least educated and most educated Wider sample Better treatment of housing wealth

34. 34 Conclusions Preparation for retirement adequate at population level. Some have under-saved but with measurement error; hard to say how many. But less educated have under-saved on average Have used observed spending levels and age-patterns: a good guide to future? Obvious question: future out-of-pocket health care costs. So far not a big problem

35. 35 Flat since 1992 among those 62-74 Possible upward movement among those 75+, but not dramatic.

36. 36 Next Steps