SSRN-Lifetime Earnings, Social Security Benefits, and the Adequacy of Retirement Wealth Accumulation by Eric Engen, William Gale, Cori Uccello: "Engen, Galle, and Uccello provide new evidence on the adequacy of household retirement saving." Their findings may surprise some given the gloom and doom reporting by many in the popular press.
Short Version: the wealthy and middle class largely are saving enough, but the poor are not.
Longer version: It is no secret that "The United States has traditionally depended on the so-called three-legged stool -- Social Security, private pensions, and additional personal saving -- to finance retirement, but all three legs are becoming increasingly creaky. " So Engen, Galle, and Uccello provide a valuable service when they investigate (via simulation) the degree to which the "additional personal savings" leg is up to the task of filling in any gaps that may (will?) exist after pensions and social security.
The paper is remarkably thorough and well done in investigating everything from tax rates, to death rates, to savings rates, to returns on investment, to the optimal color of kitchen sinks (ok, you got me there, just wanted to make sure people were still reading :) )
Not surprisingly they find the wealthy are doing fine with respect to savings. Somewhat surprisingly, the middle income earners seem to be doing OK as well. The poorest 25% of the population however is not saving enough (SHOCK!).
In possibly the biggest contribution of the paper, it acknowledges that life is risky. Doing so forces the researcher to incorporate this randomness into any analysis. This makes for a much more robust and complete model.
A further consequence of the risk is that people do not know exactly how much to save and that some people may not be able to save as much as they had planned. In the words of the authors: "in a stochastic life-cycle model that allows for uncertainty in earnings and mortality. Uncertainty about future earnings implies that there will be a distribution of optimal wealth-earnings ratios, rather than a single benchmark ratio, among households that are otherwise observationally equivalent (that is, have the same age, education, pension status, marital status, and wage history). This finding fundamentally changes the interpretation of observed saving patterns relative to a non-stochastic model. In particular, it implies that some households should be expected to exhibit low ratios of wealth to lifetime earnings even if every households is forward-looking and making optimal choices."
Of course, everyone wants to know what would happen in the event of a cut in social security. The authors test this and find that a cut would be harmful to those without enough savings (really!?).
More shocking is their claim that "The overall effect of a 30 percent social security benefit reduction is several times as large as the effects of a 40 percent reduction in stock market values." (FTR they unfortunately have seemingly ignored the economic effects of a 40% drop in stock value. (Example it would also impact pensions, income, etc)). Predictably, they find that a 40% decline in stock values would not impact all families equally:
1. "There is essentially no effect on highly-educated households".
2. "The change would hit moderate earnings households particularly hard."
Overall: An important paper that should take some of the fear out of retirement savings discussions.
All quotes signify direct quotes of the authors work. The actual paper is copyrighted by the authors. (not sure why that would not be assumed, but the paper says to put it in, so I did.