People often assume that the retirement needs of low-wage workers are covered by Social Security's progressive benefit formula. However, this assumption has never been correct.
The Role of Social Security in Retirement
Social Security was never intended to be the sole source of income for any group of retirees. In fact, Social Security replacement rates, which measure benefits as a percentage of preretirement earnings, fall far below the generally accepted benchmarks.
The Impact on Low Earners
Low earners are more likely to claim early, which results in an actuarial reduction in their replacement rate. This means that at age 62, Social Security currently replaces just 41% of a low-paid worker's preretirement earnings. For those low-income workers who must pay some or all of their Medicare premiums, the net replacement rate from Social Security is even lower. Consequently, low-income workers, like their middle- and higher-paid counterparts, need supplementary retirement income.
Vanguard's Report on Retirement Readiness
A new report from Vanguard supports this notion. The researchers estimate retirement readiness for different cohorts and income groups. They combine inputs from Vanguard's capital market model with empirical data on household balance sheets, savings rates, and spending patterns to gauge retirement readiness.
Read: Social Security's Trust Fund Is 10 Years From Depletion. Can You Save Enough to Offset a Benefit Cut?
Comparing Replacement Rates for Retirement Readiness
Retirement readiness involves comparing two replacement rates:
- The sustainable replacement rate: This represents the highest level of consumption as a share of preretirement income that the worker can sustain in 90% of market return/mortality scenarios.
- The target replacement rate: This is based on retirement spending needs inferred from national survey data.
The difference between these two replacement rates indicates the household's projected savings gap at age 65.
Read: 'We Stay in Two-Star Hotels': We're 70 and Have $1.8 Million, but My Husband Insists on Living Cheap. Don't We Have Enough?
Retirement Savings: A Closer Look at the Numbers
The latest findings, presented in Figure 1, shed light on the state of retirement savings across different income groups and generations. While high-income workers seem to be on track to meet their financial needs in retirement, the outlook is less promising for everyone else.
For individuals at the 70th percentile of the income distribution, the projected shortfall in retirement savings is comparatively small. Moreover, the situation improves significantly for younger cohorts, offering some hope for their future financial security.
Unfortunately, the story is much bleaker for the lower half of the population. Those at the 25th and 50th percentiles of the income distribution face significant gaps between their target and projected replacement rates. Although there is a slight improvement in the situation for younger generations at the 50th percentile, low-wage workers across all cohorts continue to struggle.
These findings echo those of other reputable sources. The Center for Retirement Research has been publishing the National Retirement Risk Index, a less elaborate version of this study, since 2006. Consistently, it has highlighted the inability of a large portion of working-age households in the bottom third of the income distribution to maintain their pre-retirement standard of living. The confirmation of these results by yet another respected source is encouraging.
Nevertheless, one crucial aspect highlighted by the Vanguard study is the need for low-wage workers to have access to savings options. This concern has paved the way for the implementation of Auto-IRA programs in 14 states, which provide a retirement savings solution for employees without access to an employer-sponsored plan. These initiatives are vital, and we must endeavor to strengthen them further.
Addressing the challenges faced by low-wage workers also underscores the significance of the expanded Savers Credit initiative. By incentivizing savings through tax credits, this program offers some relief to individuals with limited incomes. Lastly, the numbers underscore the urgency of finding a sustainable solution for the future of Social Security before its trust fund reserves are exhausted in the early 2030s.
