Even with the benefit of Social Security checks, low-income workers fall considerably short of replacing their income in retirement, emphasizing a need for policymakers and plan sponsors to step in to help improve options, according to Vanguard’s newest research.  

By providing wider access to workplace retirement plans and implementing features like automatic enrollment and “under-saver sweeps,” policymakers and plan sponsors have an opportunity to help low-income workers address this shortfall. Delaying retirement and liquidating home equity are also strategies to improve retirement readiness, Vanguard found in its Retirement Outlook report, published on Tuesday. 

Across all income groups, the report stated the goal for an average saver is to replace at least 70% to 85% of pre-retirement income in retirement, but the “sustainable income replacement rate” varies by income bracket. 

The report estimated that Social Security replaces 62% of income for families of late Baby Boomers—ages 61-65—that earn a median income of $22,000. But for families in this income bracket, the lowest-income group in the research, Vanguard found that Social Security income combined with income from private savings only totals 64% of families’ pre-retirement income, or about $14,080. 

The report showed, however, that families in that income group realistically need to replace 96% of their income to meet their retirement spending needs, which leaves families about 32 percentage points, or $7,040, short of sustainable income replacement.  

The report uses “family” as the unit of analysis because the Federal Reserve’s Survey of Consumer Finances, on which the report is based in part, provides balance sheet information for families. In some cases, a family may reflect a family of one, according to Fiona Greig, global head of investor research and policy at Vanguard and one of the report’s authors. 

On the other side of the spectrum, for families in the highest income group, with a median income of $173,000, Social Security replaces 18% of their income, but due to private savings, families are able to maintain a sustainable replacement rate of 63%. Their target, however, was only about 43% of their income, $74,390, to cover spending needs, leaving high-income families with a sustainable replacement rate 20 percentage points greater than their spending needs.  

Using those calculations, when comparing the entire income spectrum, high-income families have a sustainable replacement rate that more than meets their spending needs, while everyone else falls short.  

Access to Home Equity, Working Longer Boosts Retirement Readiness 

When workers delayed retirement or drew on home equity, Vanguard found that retirement readiness improved.  

The ability to liquidate home equity is particularly significant for late Boomers in the lowest-income quartile, as it would erase 12 percentage points of the median worker’s 32-percentage-point retirement readiness gap. Home equity also could enhance the highest-income Boomer’s surplus, raising the sustainable replacement rate by seven percentage points.  

Other strategies like using a reverse mortgage, downsizing or relocating to a lower-cost housing market can also potentially increase a retiree’s home equity extraction and, as a result, build their retirement readiness. 

Vanguard’s baseline analysis also assumed that workers retire at age 65, consistent with the average retirement age in 2021. But an additional year of work would enhance retirement income for all cohorts, boosting sustainable replacement rate by two to five percentage points.  

“Delayed retirement increases the number of years when workers can rely on wage income and reduces the number of years when they depend on their portfolios,” the report stated. 

This strategy also increases Social Security benefits, because the older one retires and the later someone claims Social Security, the higher one’s monthly Social Security check will be.  

However, this assumes that Social Security benefits will not be reduced. The Social Security Administration Board of Trustees projected in March that the Social Security trust fund is on pace to become depleted by 2033. 

Because Social Security replaces a larger share of lower-income workers’ wages, Vanguard projected that benefit reductions would hit this group the hardest. For late Boomers in the lower-income quartile, a 23% Social Security benefit reduction would reduce their sustainable rate by 14 percentage points. 

Brighter Hope for Gen X, Millennials 

While those in Generation X and Millennials have faced rising costs in higher education and health care and have less access to DB pensions, Vanguard concluded that these cohorts have a more positive retirement outlook today than the older Boomer cohort. 

Because of improvements in DC plan design, such as the addition of features like automatic enrollment and automatic escalation, more employees can join workplace plans and increase their savings rates over time.  

Vanguard found that among the different age groups in the same income group, Millennials with a median income of $42,000 will be able to generate sustainable retirement income equal to 58% of their pre-retirement earnings. That is  eight percentage points better than the sustainable replacement rate for late Boomers in the same income group. The research also showed that both groups at that income level will fall short of their projected income needs. 

The generational gains in retirement readiness are even larger for higher-income workers. For example, Millennials with a median income of $61,000 are on track to reach a sustainable replacement rate of 66%, a 15-percentage point increase over Boomers in the same income bracket. Spending needs for this income group are projected to be 68% of pre-retirement income. 

Time For Policymakers, Plan Sponsors to Act 

As Social Security will not be enough to meet low-income workers’ spending needs in retirement, policymakers have an opportunity to help this population participate more in capital markets, allowing for higher long-term returns. Vanguard found that these workers tend to be overinvested in cash, which until recently did not produce significant growth.  

Plan sponsors could also accelerate initiatives to auto-enroll employees and implement auto-escalation. At the end of 2022, for example, 42% of the employer-sponsored DC plans on Vanguard’s recordkeeping system had yet to adopt auto-enrollment.  

“The tangible steps that plan sponsors and consultants have taken to improve plan design with features such as automatic enrollment and age-appropriate asset allocations have improved outcomes for retirement savers, especially Millennial and Gen X savers,” David Stinnett, Vanguard’s head of strategic retirement consulting, said in an emailed response.

Conducting re-enrollment campaigns that periodically default nonparticipants in the plan, such as “under-saver sweeps,” can also help ensure that participants are saving enough to maximize the employer match for their contributions.  

Ensuring that retirement savings remain invested when workers move from one job to the next is also important. Vanguard recommended that plan sponsors implement automatic portability measures to prevent savings leakage. 

Vanguard assessed retirement readiness for 12 generational and income cohorts using the Federal Reserve Board’s Survey of Consumer Finances waves from 1989 to 2019, and the sample included men and women from three generational cohorts based on their age in 2022.  

Read more @plansponsor