Life-Cycle Earnings Curves and Safe Savings Rates
By Derek Tharp (Kansas State University) & Michael E. Kitces (The Kitces Report & Nerd’s Eye View)
Traditional analyses of recommended savings ratios and safe savings rates (SSRs) typically assume constant real earnings growth throughout the one’s career. However, data on the life-cycle earnings patterns of millions of U.S. workers suggests that earnings growth does not occur at a constant rate that matches inflation. Instead, earnings tend to increase at a decreasing rate during the early years of one’s career and decrease at an increasing rate in the later years. Utilizing simulations of saving and dissaving throughout the life-cycle based on historical market returns, the impact of assuming more realistic earnings growth relative to constant inflation-adjusted growth is examined. Results indicate that failing to account for more realistic earnings curves throughout the life-cycle may overstate SSRs for lower-income households while understating SSRs for higher-income households and understate SSRs for younger households while overstating SSRs for older households. Furthermore, historical SSRs of 10% or less are found for all but the highest income households after accounting for more realistic earnings curves and Social Security benefits.
Full Content: SSRN
