How Does Local Cost-of-Living Affect Retirement?

Households across the United States face very different cost-of-living, largely due to variations in housing expenses. Over the last 50 years, house prices have risen fastest in already expensive areas. To attract workers despite high prices, these local labor markets offer more wages and/or fringe benefits. Wage levels directly affect retirement security through Social Security benefits, which, by design, replace a higher share of pre-retirement earnings for workers at the bottom of the national earnings distribution, not taking local price levels into account. As a result, households in high-cost areas could face a replacement-rate penalty if their employers offer higher wages. The questions are: 1) How large is this penalty in practice? and 2) Do workers respond to the penalty by adjusting their behavior? This brief, based on a recent paper, uses the Health and Retirement Study to document the relationship between local cost-of-living – captured by housing prices – and Social Security replacement rates. It then explores whether households in high-cost areas compensate for lower replacement rates by responding in three possible ways: saving more during their working years; retiring later; and/or moving to a lower-cost area when they retire. The discussion proceeds as follows. The first section provides background on the link between local cost-of-living and Social Security replacement rates. The second section describes the data and methodology. The third section presents results for the association between local cost-of-living, replacement rates, and household behavior. The final section concludes that Social Security replacement rates are lower in moreexpensive areas, but the gap is somewhat smaller than anticipated because earnings have only partially kept up with the cost of financing a house. In response to the gap that does exist, households – especially the more educated – save more; and some homeowners move after retirement.