Why seniors lack sufficient retirement income

Are today's retirees struggling to tap enough income to maintain their earlier lifestyles?

In just two states — Hawaii and Nevada — households made up of people ages 65 and older are taking in at least 70% of the income earned by households with people ages 45 to 64, according to our 2013 Retirement Income Study.

Such findings suggest that both current and future retirees face an income crisis that could tarnish the shine of their golden years.

However, the picture is considerably more complex once you dig a little deeper, says Lisa Gardner, professor of statistics at Drake University in Des Moines, Iowa. Looking solely at someone's income does not tell you everything about that person's financial well-being, she says.

Gardner expands on her thoughts in the following interview.

Q: What are your initial impressions of our Retirement Income Study?

A: The subject matter of the study isn't new. Other researchers have studied the topic, too, and the most common conclusion for many years continues to be that U.S. households need to save more for retirement.

The study shows yet again the sizable share of our population aged 65 and over. It also provides yet more evidence that replacement ratios vary by state, indicating that residents of some locales seem to experience a larger reduction in standards of living during their retirement years than those living in other states.

Professor's Profile:

When reading the study's results, keep in mind at least four things. First, these figures tell a story about income, but not about net worth. Assets like homeowners' equity represent an important source of savings for many U.S. households, but unless a homeowner gets income from a reverse mortgage or something similar, homeowners' equity doesn't factor into the researchers' study.

Likewise, investors with money tied up in assets that appreciate over the long term, like some dividend-free stocks and zero-coupon bonds, for instance, will not earn income from them until they are sold. Thus, someone may have significant net worth, but not necessarily have a high income replacement ratio because their assets don't all produce income.

Second, replacement ratios focus on income and not other ways to pay bills. Specifically, replacement ratios tell us nothing about whether a household has post-retirement health insurance coverage other than that provided by Medicare. Since health care can be a significant expense for seniors, and Medicare does not pay for all expenses, a household needs to have access to either income or to health insurance to help pay for needed care.

Third, replacement ratios tell us nothing about the availability of extended family to support seniors. Children, nieces and nephews can provide assistance to seniors, assistance for which they might otherwise have to pay or pay more.

Fourth, most households do not need or want 100% (or 80%) replacement of their pre-retirement income during their retirement years. The question that we all need to ask ourselves when doing retirement planning is, “How much of my (our) pre-retirement income will my (our) household need in order to meet the needs that I (we) consider important to my (our) happiness and well-being?”

Q: What key factors are contributing to your state's standing within the study?

A: That is a good question. It is hard to know exactly why Iowa falls where it does.

Anecdotally, I would suspect that we lose many of our wealthier seniors to other states having more favorable climates and tax environments.

Due to our tax laws, Iowa is not a tax haven for retirees. We do tax Social Security benefits, sales, retiree income above $32,000 and inheritances above a certain amount. Taken together, the harsh climate and tax environment act as a disincentive for retirees to stay in Iowa. The higher one's household income is, the easier it is to afford to relocate elsewhere.

We also have a lower cost of living than the norm. This means that everyone here needs less to live comfortably, including retirees. A lower cost of living acts an incentive for those with lower incomes to remain in Iowa. This means that our state likely does not see a lot of out-migration of low-income retirees for economic reasons alone.

Let me turn now to the question of whether Iowans aged 65 and over are really worse off financially than seniors in other parts of the country. I am not sure that we can say that, based only on these income replacement ratio rankings. These rankings don't consider income stability, total net worth or the stability of net worth, for example. Iowa's unemployment rates in recent years have typically been below national jobless rates, which may mean that the incomes of Iowans have been more consistent, with a smaller share of Iowans experiencing periods of unemployment than the norm.

So I think the retirement income picture for older Iowans is not quite as bleak as what is represented by the figures in the Interest.com study. Do I think there is room for improvement? Of course there is.

Q: Why are seniors only able to achieve 70% of the income of pre-retirement workers' income in only two states?

A: Again, it is hard to know why. Nevada has no state income tax and no inheritance tax. If you have a higher income and don't want to pay inheritance tax, you may find Nevada's tax climate attractive. Clark County, where most of the population in Nevada resides, has a higher than average cost of living, so one has to have more income than average to afford to live there. Hawaii's tax benefits for retirees are even more significant, and the cost of living is among the most expensive in the U.S. In sum, there are some economic reasons that might help explain why Nevadans and Hawaiians over age 65 have a median replacement ratio above 70%.

Q: How would proposals to move toward a chained CPI affect seniors' ability to reach 70% to 80% of pre-retirement cohorts' income?

A: The Consumer Price Index (CPI) is currently used to increase Social Security, veterans and food stamp benefits over time. The calculation incorporates the costs of several things.

A chained CPI considers the costs of several things, but takes into account the fact that when the price of one item rises (for example, an apple), consumers do not pay more for the item; they substitute another, lower-priced item instead (for example, an orange). This means that the chained CPI will rise more slowly over time than does the CPI.

Budget hawks see it as a way to lower the deficit. However, the savings come because Social Security, veterans and food stamp benefits will rise more slowly over time. This means less money in the pockets of some of the most vulnerable populations in our country — our seniors, wounded veterans and the poor.

Q: How much are current seniors benefiting from having traditional pensions as opposed to the 401(k) plans of many baby boomers?

A: The level of benefit provided depends upon the funding formula, whether the worker is vested at retirement and whether the pension plan is financially solvent.

In contrast, 401(k) plans are funded by employees and sometimes employers. The employee has some discretion in deciding how much to invest, how often to invest and where to invest. The amount of income available for an employee's retirement varies, depending on how much was invested, how often it was invested and the rate of return earned over time.

Because many baby boomers have proven to be poor savers with 401(k) plans — with many contributing too little, taking early withdrawals or taking out loans against their plans — they may have been better off with defined-benefit plans. But I doubt that defined-benefit plans will make a big comeback in the U.S.

Special thanks to Prof. Gardner and Drake University
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