Potential Consequences for Saving, Work, and Retirement Plans
Karen E. Smith, C. Eugene Steuerle, Damir Cosic
October 2021 Program on Retirement Policy
Each of the three pillars of the US retirement system — Social Security, employer pensions, and private savings — suffers from serious problems that could threaten the financial security of future retirees. Social Security is at risk of becoming insolvent. If policymakers fail to act, Social Security benefits will be cut by about 25 percent starting in 2035, and even with reform, some combination of a slowdown in benefit growth for retirees and higher taxes on workers likely will occur. As policymakers are forced to tackle significant changes to Social Security costs and revenues for the first time since 1983, they could seize the opportunity to bolster the broader retirement income system. Structural reforms to this system could include strengthening work incentives, bolstering private retirement saving, and ensuring better financial security for low-income seniors and disabled individuals.
This study first quantifies the share of Social Security beneficiaries, both aged and disabled, as well as elderly persons eligible for Supplemental Security Income (SSI), who are deemed to have inadequate retirement income. While we quantify that level of inadequacy under current law, with its scheduled, cliff-like, across-the-board cuts in Social Security benefits, we believed it more relevant for most purposes to measure the level of inadequacy likely to remain under a more realistic scenario.
For that purpose, we chose the Social Security component of a reform proposal adopted by the Bipartisan Policy Center’s (BPC’s) Commission on Retirement Security and Personal Savings. The BPC proposal aimed to achieve solvency roughly half through benefit cuts and half through tax increases. While this proposal substantially improves retirement security compared with current law, by many measures it still leaves many Social Security beneficiaries with inadequate retirement income. We start with a traditional measure of adequacy equal to a 75 percent replacement of preretirement income. We hold this constant relative to average wages throughout retirement to allow for the effect of new goods and services, including health care, on what might be adequate, say, at age 65 versus 85.
We then supplement that measure in two ways. First, we include a minimum absolute standard of adequacy equal to 25 percent of the average wage in the economy, not far from the official poverty measure for a single person in 2020. Second, individuals achieving incomes higher than the average earnings of workers ($54,000 in 2019) are assumed to have achieved adequacy regardless of their replacement rate In addition to getting a handle on the size and composition of those with inadequate retirement income under current law and a sustainable Social Security system, we next attempt to quantify the extent to which adequacy gaps can be reduced through additional work and additional saving. We further examine how a well-targeted Social Security minimum benefit reform could improve retirement income adequacy for those with income near or below the federal poverty level in retirement. Using the Urban Institute’s Dynamic Simulation of Income (DYNASIM) microsimulation model, we project that under current law, the share of Social Security beneficiaries with inadequate income will increase from 26 percent in 2020 to 45 percent by 2090, including a sharp increase after 2034 when, absent Congressional action, Social Security can cover only about four-fifths of scheduled benefits.
While the BPC proposal avoids that level of benefit cut, it still leaves 39 percent of beneficiaries falling short of this standard by 2090. Working longer by one year, by two years, or in line with increases in life expectancy would reduce the share of Social Security beneficiaries unable to replace 75 percent of their preretirement earnings by 2 to 5 percentage points. Working longer generates more earnings, allows workers to save more, and reduces the number of years that any accumulated savings need to fund. Workers who also delay claiming Social Security receive permanently higher future benefits. Still, unless working longer is paired with delayed Social Security claiming, or, unless the government uses the extra revenues to fund other retirement supports, working longer generates only modest increases in retirement income because added late-career savings have little time to grow. That is, only a portion of those gains directly increase incomes in retirement rather than consumption before retirement. Aperson with a 50 percent replacement rate, for example, might increase that number to 54 percent with an extra year of work but still fall short of the target replacement rate.
An immediate but permanent increase in the saving rate initially has a smaller impact on retirement income adequacy than an immediate but permanent increase in years of work, but in later years, saving more has a bigger impact on retirement income adequacy.
By 2065, more saving reduces the share of Social Security beneficiaries unable to replace 75 percent of preretirement earnings by 5 to 13 percentage points. The higher the saving rate, the greater the share of beneficiaries achieving adequate retirement income.
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