Reassessing Retirement Preparedness

The Federal Reserve’s Survey of Consumer Finances (SCF) release gives us an opportunity to reconsider Americans’ retirement readiness using the National Retirement Risk Index (NRRI).

What is the NRRI?

The NRRI estimates the percentage of American households that may struggle to maintain their standard of living in retirement.

Three Key Steps

1. Replacement Rate Projection: Calculating retirement income compared to preretirement income for a sample of working-age households.

2. Target Replacement Rate: Determining the replacement rate needed to sustain the preretirement lifestyle in retirement.

3. Risk Assessment: Comparing projected and target replacement rates to identify households “at risk.”

Impact of Recent Events

The last SCF conducted in 2019 was followed by a series of challenges, including a global pandemic and economic instability resulting in a tough year for stock and bond returns in 2022. Despite these obstacles, the government’s financial aid, consistent employment rates, increased home values, and a rebounding stock market led to an overall positive outcome for household financial preparedness.

Positive Trends

The 2022 NRRI report highlights a significant improvement in household financial security, with the share of households at risk decreasing from 47% in 2019 to 39% in 2022 (refer to Figure 1). The rise in asset values proved to be instrumental in offsetting economic setbacks, resulting in the lowest level of households at risk since the inception of NRRI.

Analysis of the NRRI Reduction

In Figure Two, we see a breakdown of the significant decrease in the NRRI. The primary factor is the rise in home prices, followed by increased savings during the pandemic and gains in the stock market. Although rising interest rates have a mitigating effect by limiting home equity accessible through reverse mortgages.

Implications for the Future

The 2022 results suggest that two main drivers of the notable NRRI improvement are unlikely to be sustained. Firstly, housing prices currently stand about 14% above their long-term trend and may regress over time. Secondly, the surge in “new saving” is likely a one-time effect of COVID-19. With personal saving rates and credit card borrowing returning to pre-pandemic levels, the remarkable decrease in households at risk might not be sustainable.

Future NRRI Outlook

If we assume the positive trends persist, future NRRIs could stabilize around 40%. This indicates that approximately 40% of today’s working-age households may lack sufficient retirement income to maintain their standard of living post-retirement. Consequently, there is a clear need for reforms within our retirement system to ensure the financial stability of Social Security and promote universal coverage under employer plans.