Increase in Retirement Preparedness Among Households May Be Temporary
The release of the Federal Reserve’s Survey of Consumer Finances (SCF) has shed light on the retirement preparedness of American households. The National Retirement Risk Index (NRRI), which measures the percentage of households at risk of not being able to maintain their preretirement standard of living in retirement, offers valuable insights into the current state of retirement readiness.
To construct the NRRI, three steps are taken. First, a replacement rate is projected, which refers to retirement income as a share of preretirement income, for a nationally representative sample of working-age households. Second, a target replacement rate is established to ensure a preretirement standard of living can be maintained in retirement. Lastly, the projected and target replacement rates are compared to determine the percentage of households “at risk.”
The latest SCF conducted in 2019 was followed by a global pandemic and economic disruption in 2020, making 2022 a challenging year for stock and bond returns. These factors would have undoubtedly impacted households’ retirement preparedness. However, the government’s unprecedented fiscal support, strong employment rates, substantial rise in home values, and a stock market that rebounded significantly compensated for the economic disruption. As a result, the 2022 NRRI revealed the lowest level of households at risk since its inception. The share at risk dropped from 47% in 2019 to 39% in 2022.
Examining the reasons for this significant reduction in the NRRI, it becomes evident that rising home prices played a crucial role, followed by new savings during the pandemic and stock market gains. However, the positive impact of rising interest rates was mitigated by the decrease in home equity available through reverse mortgages.
While the 2022 results are encouraging, it is essential to consider their implications for the future. Two major contributors to the remarkable improvement in the NRRI are unlikely to persist. First, housing prices are currently 14% above their long-term trend and may eventually revert to the mean. Second, the surge in “new saving” is likely a one-time occurrence linked to the COVID-19 pandemic. Personal saving rates have returned to pre-pandemic levels, and credit card borrowing has also normalized. Therefore, the substantial decline in the percentage of households at risk may not be sustainable in the long run.
Assuming the positive trend continues and future NRRIs hover around 40%, it implies that approximately two-fifths of today’s working-age households will still face inadequate retirement income to maintain their preretirement standard of living. This analysis emphasizes the need to address the flaws in our retirement system, including ensuring the financial stability of Social Security and universal coverage for employer-sponsored plans.
In conclusion, while the decrease in the percentage of households at risk of insufficient retirement income is a positive development, it may be temporary. The factors that contributed to this improvement, such as rising home prices and new savings during the pandemic, are unlikely to persist. Therefore, it is crucial to implement reforms to create a robust retirement system that provides financial security for all Americans in their golden years.
