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Key Findings Details

Measuring Economic Preparation for Retirement: Income Versus Consumption
Michael Hurd and Susann Rohwedder
WP 2015-332

• The income replacement rate (IRR), the ratio of income after retirement to earnings before retirement, was developed to help people plan financially for retirement. For many people, however, such a broad rule of thumb is simplistic and misleading. The IRR does not consider other sources of support in retirement such as financial wealth; in the case of married persons it does not have a good way of defining retirement.

• We augmented the simplest of the IRR by including a drawdown of financial and IRA wealth; we defined and estimated a household IRR to more fully account for the advantages of dual-earner households in which joint ownership of resources results in savings. The augmented measures increased the percentage of the population economically prepared for retirement by as much as 20 percentage points over the simple measure.

• We compared these extended IRRs with a measure of economic preparation based on consumption, which is theoretically preferable because consumption translates directly into well-being. Further, in the consumption-based measure, we accounted for the likelihood of events that impact spending needs many years into retirement. Our estimated consumption-based measure indicates retirement preparation at 59 percent for single persons and 81 percent for couples, well over the quantities derived from income replacement rates (46 percent for both single and married persons). Moreover, there is little relationship between the income replacement measures and the comprehensive consumption-based measures. Even when broadened in scope, the IRRs do not give good guidance to individual households.