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Measuring Economic Preparation for Retirement: Income Versus Consumption

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  • Michael D. Hurd

    (RAND, NBER, MEA and NETSPAR)

  • Susann Rohwedder

    (RAND and NETSPAR)

Abstract

The income replacement rate (income immediately following retirement divided by income immediately preceding retirement) has become widely used as a measure of economic preparation for retirement. Yet a number of relevant issues are not adequately captured by the replacement rate concept. These include nontraditional transitions from full employment to full retirement, nonparallel transitions by the members of a married couple, and the ability to finance consumption out of savings. In this paper we estimate several measures of the income replacement rate that address some of these issues. Then we compare these income replacement rates with a consumption-based measure of economic preparation that takes into account the ultimate consequences for the retirement-to-death consumption path. Broadly speaking, the measure finds whether a household has, with high probability, the resources to finance a trajectory of spending from shortly following retirement until death. Our preferred measure of the income replacement rate somewhat understates the percentage of single persons adequately prepared for retirement, but it grossly understates the percentage of married persons adequately prepared. Furthermore, there is little relationship between the income replacement rate and our consumption-based measure. The implication is that the income replacement rate is of little use for assessing economic preparation for retirement: the chances that someone with a low income replacement rate is well prepared are not much different from the chances that someone with a high income replacement rate is well prepared.

Suggested Citation

  • Michael D. Hurd & Susann Rohwedder, 2015. "Measuring Economic Preparation for Retirement: Income Versus Consumption," Working Papers wp332, University of Michigan, Michigan Retirement Research Center.
    • Handle: RePEc:mrr:papers:wp332
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    References listed on IDEAS

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    1. Alicia H. Munnell & Mauricio Soto, 2006. "What Replacement Rates Do Households Actually Experience In Retirement?," Working Papers, Center for Retirement Research at Boston College wp2005-10, Center for Retirement Research.
    2. Michael J. Boskin & John B. Shoven, 1984. "Concepts and Measures of Earnings Replacement During Retirement," NBER Working Papers 1360, National Bureau of Economic Research, Inc.
    3. Andrew G. Biggs, 2011. "Social Security: The Story of Its Past and a Vision for Its Future," Books, American Enterprise Institute, number 6033, September.
    4. Andrew Au & Olivia S. Mitchell & John W. R. Phillips, 2004. "Modeling Lifetime Earnings Paths: Hypothetical versus Actual Workers," Working Papers wp074, University of Michigan, Michigan Retirement Research Center.
    5. Alicia H. Munnell & Anthony Webb & Rebecca Cannon Fraenkel, 2013. "The Impact of Interest Rates on the National Retirement Risk Index," Issues in Brief ib2013-9, Center for Retirement Research.
    6. Alicia H. Munnell & Anthony Webb & Francesca Golub-Sass & Dan Muldoon, 2009. "Long-term Care Costs and The National Retirement Risk Index," Issues in Brief ib2009-9-7, Center for Retirement Research, revised Mar 2009.
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