For other versions of this document, see http://wikileaks.org/wiki/CRS-RL33845 ------------------------------------------------------------------------------ ¢ ¢ ¢ Prepared for Members and Committees of Congress ¢ ¢ Over the past 25 years, an important change has occurred in the structure of employer-sponsored retirement plans in the private sector. Although the percentage of the workforce who participate in employer-sponsored retirement plans has remained relatively stable at approximately half of all workers, the type of plan by which most workers are covered has changed from defined benefit (DB) pensions to defined contribution (DC) plans. The responsibilities of managing a DB plan-- making contributions, investing the assets, and paying the benefits to retired workers and their survivors--lie mainly with the employer. In a typical DC plan, the worker must decide whether to participate in the plan, how much to contribute, how to invest the contributions, and what to do with the money in the plan when he or she changes jobs or retires. As a result of the shift from DB plans to DC plans, workers today bear more responsibility for preparing for their financial security in retirement. According to data collected by the Federal Reserve Board, 45% of households in which the householder or spouse was employed contributed to employer-sponsored retirement plans in 2004, and 58% owned a retirement account of any kind. Among married-couple households in which the householder was under age 35, the median balance in all retirement accounts owned by the household was $19,000 in 2004. Among unmarried householders, the median retirement account balance in 2004 was just $7,000. Among married-couple households headed by individuals between 45 and 54 years old, median retirement assets in 2004 were $103,200. Unmarried householders aged 45 to 54 had a median balance of $32,000. Most households that participated in defined contribution plans in 2004 contributed between 3% and 10% of pay to the plan. Younger households with median earnings contributed about 5% of pay, while median- earnings households 45 and older contributed about 6% of pay. The report also presents the results of an analysis of the amount of retirement savings that households might be able to accumulate by age 65 under a number of different scenarios. The analysis shows how varying the age at which households begin to save for retirement, the percentage of their earnings that they save, and the rate of return on investment can affect the amount of retirement savings the household will accumulate. Using Monte Carlo methods that simulate the variability of investment rates of return, we found that a married-couple household that contributed 8% of pay annually for 30 years beginning at age 35 to a retirement plan invested in a mix of stocks and bonds could expect have accumulated $468,000 (in 2004 dollars) by age 65 if rates of return were at the median over the 30-year period. Nevertheless, given the variability of rates of return, there is a 5% chance that the couple would have $961,000 or more and a 5% chance that the couple would have $214,000 or less. Higher contribution rates and longer investment periods lead to higher account balances, but also increase the impact of the variability of investment rates of return. At a 10% contribution rate over 30 years, the household could expect to accumulate $594,000, with a 90% probability that account would total between $301,000 and $1.2 million. Saving 8% of pay over 40 years, the household could expect to accumulate $844,000, with a 90% probability that the account would total between $370,000 and $2 million. This report will not be updated. ¢ Trends in Retirement Plan Design................................................................................................... 1 Growing Prevalence of Defined Contribution Plans................................................................. 2 Retirement Savings of American Households ................................................................................. 3 Retirement Account Balances in 2004 ...................................................................................... 4 Amount of Contributions .......................................................................................................... 7 How Much Might Workers Accumulate by Age 65?......................................................................11 Methods................................................................................................................................... 12 What is "Monte Carlo" Analysis? ................................................................................................. 13 Simulation Results: Retirement Account Balances at Age 65 ....................................................... 13 Variability of Investment Rates of Return............................................................................... 14 Length of Investment Period................................................................................................... 15 Contribution Rates .................................................................................................................. 16 Household Earnings ................................................................................................................ 17 Simulation Results: Measuring Retirement Income Adequacy..................................................... 18 Annuities: Insurance Against Longevity Risk............................................................................... 19 Measuring Earnings Replacement Rates................................................................................. 20 Married Couples Versus Singles ............................................................................................. 22 Detailed Simulation Results .................................................................................................... 24 Policy Considerations.................................................................................................................... 27 Conclusion..................................................................................................................................... 28 Figure 1. Effect of Variability in Investment Rates of Return on Retirement Savings at Age 65 ........................................................................................................................................ 14 Figure 2. Effect of Age at Which Savings Begins on Retirement Savings at Age 65 ................... 16 Figure 3. Effect of Annual Contribution Rate on Retirement Savings at Age 65.......................... 17 Figure 4. Effect of Household Earnings on Retirement Savings at Age 65................................... 18 Figure 5. Estimated Range of Earnings Replacement Rates at Age 65 for a Married- Couple Household with Median Earnings.................................................................................. 22 Figure 6. Estimated Retirement Savings at Age 65 or Married Couple and Unmarried Householders.............................................................................................................................. 23 Figure 7. Earnings Replacement Rates at Age 65 of Married Couples and Unmarried Householders.............................................................................................................................. 24 Table 1. Number of Plans and Active Participants, by Type of Plan, 1980-2003............................ 1 ¢ Table 2. Household Participation in Defined Contribution Plans at Current Employer in 2004.............................................................................................................................................. 5 Table 3. Household Retirement Account Balances in 2004 ............................................................ 6 Table 4. Contributions to Employer-Sponsored Plans in 2004........................................................ 8 Table 5. Contributions to Employer-Sponsored Plans in 2004...................................................... 10 Table 6. Retirement Savings and Income Replacement Rates, Based on Annual Total Contributions Equal to 8% of Household Earnings ................................................................... 25 Table A-1. Household Earnings in 2004, by Age and Marital Status of Householder and Percentile Rank of Earnings ....................................................................................................... 30 Table A-2. Annual Total Return on Stocks and Bonds and Annual Rate of Change in the Consumer Price Index, 1926-2005............................................................................................. 31 Table A-3. Retirement Savings and Income Replacement Rates, Based on Annual Total Contributions Equal to 6% of Household Earnings ................................................................... 32 Table A-4. Retirement Savings and Income Replacement Rates, Based on Annual Total Contributions Equal to 10% of Household Earnings ................................................................. 34 ¡ Appendix. Historical Data and Estimates of Savings.................................................................... 30 Author Contact Information .......................................................................................................... 36 ¢ Over the past 25 years, an important change has occurred in the structure of employer-sponsored retirement plans in the private sector. Although the percentage of the workforce who participate in employer-sponsored retirement plans has remained relatively stable at approximately half of all workers, the type of plan by which most workers are covered has changed. In 1980, the majority of workers participated in defined benefit (DB) pensions. (See Table 1.) Generally, workers in DB plans do not have to elect to participate. All covered workers earn benefits under the plan, and the benefits typically are based on the number of years of service by the employee and some measure of the worker's average salary. At retirement, benefits typically are paid as an annuity that provides the retiree with a monthly income for life. The Employee Retirement Income Security Act of 1974 (ERISA, P.L. 101-508) requires an employer that sponsors a defined benefit (DB) plan to establish a trust fund that holds assets sufficient to pay the retirement benefits earned by the workers who participate in the plan.1 The responsibilities of managing a DB plan--making contributions, investing the assets, and paying the benefits to retired workers and their survivors--lie mainly with the employer. 3002-0891 ,nalP fo epyT yb ,stnapicitraP evitcA dna snalP fo rebmuN .1 elbaT raeY snalP BD stnapicitraP BD snalP CD stnapicitraP CD 0891 690,841 000,001,03 508,043 000,688,81 5891 271,071 000,598,82 369,164 000,861,33 0991 260,311 000,502,62 542,995 000,043,53 5991 294,96 000,593,32 219,326 000,302,24 0002 377,84 000,812,22 878,686 000,478,05 3002 630,74 000,403,12 679,256 000,828,15 stropeR launnA 0055 mroF fo tcartsbA :nitelluB nalP noisneP etavirP ,robaL fo tnemtrapeD .S.U :ecruoS suoirav , .sraey :etoN .sboj tnerruc rieht ta snalp ni gnitapicitrap srekrow era stnapicitrap evitcA Today, a majority of workers participate in 401(k)-type plans rather than in traditional defined benefit pensions. These are called defined contribution (DC) plans. Defined contribution plans are much like savings accounts maintained by employers on behalf of each participating employee. In a typical DC plan, the worker must decide whether to participate in the plan, how much to contribute, how to invest the contributions, and what to do with the money in the plan when he or she changes jobs or retires. Thus, in a DC plan, it is the employee who bears the investment risk and who is ultimately responsible for prefunding his or her retirement income. As a result of the shift from DB plans to DC plans, workers today bear more responsibility for preparing for their financial security in retirement. Decisions that workers make--or fail to make--from the time that they first enter the workforce can have a substantial impact on their wealth and income many decades in the future. Understanding how workers have responded to these challenges and 1 ERISA governs only private-sector plans. Retirement plans offered by state and local governments to their employees are governed by the statutes of those jurisdictions. Retirement plans for federal employees are governed by Title 5 of the United States Code. Unlike private plans, most government-sponsored DB plans require employee contributions. ¢ opportunities may help Congress develop policies that will assist workers in making the best possible decisions to provide for their financial security in retirement. This CRS report presents information on trends in retirement plan design and then summarizes data collected by the Federal Reserve Board on the retirement savings accumulated by workers and the rates at which they are saving for retirement. The report also presents the results of an analysis conducted by CRS on the amount of retirement savings that workers might be able to accumulate by age 65 under a number of different scenarios. The analysis shows how varying each of several factors, including the age at which households begin to save for retirement, the percentage of their earnings that they save, and the rate of return on investment can affect the amount of retirement savings the household will accumulate. The accumulated savings is then converted into an annuity to illustrate the share of pre-retirement earnings that the accumulated retirement savings could replace. The rapid growth of defined contribution plans began in the 1980s. In 1978, Congress added section 401(k) to the Internal Revenue Code, which allowed employees to contribute part of their current pay into a retirement plan on a pre-tax basis.2 In 1981, the Internal Revenue Service (IRS) published regulations for "cash or deferred arrangements" established under §401(k), into which employees can make pre-tax contributions, and in which interest, dividends, and capital gains accrue on a tax-deferred basis until the money is withdrawn.3 Since that time, DC plans have overtaken defined benefit pensions in the number of plans, the number of participants, and total assets. In 2006, only 20% of all workers in the private sector were included in defined benefit pension plans, while 43% participated in defined contribution plans. About 12% of workers participated in both types of plan.4 DB and DC plans also differ with respect to participation. In general, all workers who meet the requirements for coverage under a DB plan automatically earn benefits under the plan. The employer prefunds the benefits that will be paid to all eligible employees when they reach retirement age. In contrast, in most DC plans, the employee must elect to participate. The employee also must decide how much to contribute to the plan, and how to invest the contributions. According to the U.S. Department of Labor, 20% of workers whose employers sponsored DC plans did not participate in these plans in 2006.5 One way to boost enrollment in DC plans would be to enroll all eligible employees automatically. More firms, particularly among large employers, have adopted automatic enrollment in recent 2 Defined contribution plans had existed for many years, but prior to enactment of I.R.C. §401(k), they were funded by employer contributions or after-tax employee contributions. 3 401(k) plans cover mainly workers in for-profit businesses in the private sector. Workers in non-profits are sometimes covered under 403(b) plans and workers in state and local governments are sometimes covered under 457 plans. 4 The Labor Department reports that 51% of private sector workers were in any type of plan. Twenty percent were in DB plans and 43% were in DC plans. (43% + 20% - 51% = 12%). 5 Fifty-four percent of workers in the private sector worked for employers who sponsored defined contribution plans in 2006, and 43% of private-sector workers participated in DC plans. Assuming that all workers whose employers sponsored a DC plan were eligible to participate, these figures imply a participation rate of 80% among eligible employees. (National Compensation Survey: Employee Benefits in Private Industry, U.S. Department of Labor, Bureau of Labor Statistics, Summary 06-05, Aug. 2006, Table 2, p. 7.) ¢ years. According to the Profit Sharing/401(k) Council of America, 17% all 401(k) plans had automatic enrollment in 2005, up from 11% in 2004. Automatic enrollment had been adopted by 34% of plans with 5,000 or more participants by 2005, compared to just 4% of plans with fewer than 50 participants. The Pension Protection Act of 2006 (P.L. 109-280) contains provisions that are intended to encourage employers to adopt automatic enrollment in defined contribution plans. Plans with this feature will be exempted from certain tests for discrimination in favor of highly- compensated employees, a practice that is prohibited by law. With the trend away from defined benefit plans to defined contribution plans, workers now bear much of the responsibility of preparing for retirement. Workers whose employers offer savings or "thrift" plans such as those authorized under §401(k), §403(b), and §457 of the Internal Revenue Code can accumulate assets on a tax-deferred basis while they are working. Most people with earned income also can contribute to an individual retirement account (IRA). In 2007, IRA contributions of up to $4,000 (or $5,000 for people 50 and older) are tax-deductible for workers who are not covered by a retirement plan at work.6 In these plans, taxes are paid when the funds are withdrawn, and a penalty may apply if the withdrawal occurs before retirement. Another option is to save for retirement in a Roth IRA. Roth IRAs accept only after-tax contributions; however, withdrawals from a Roth IRA during retirement are tax-free.7 secnaniF remusnoC fo yevruS ehT sgnivas tnemeriter dna noitapicitrap nalp tnemeriter no atad stneserp troper ecivreS hcraeseR lanoissergnoC sihT hcihw rof raey tnecer tsom eht ,4002 ni )FCS( secnaniF remusnoC fo yevruS eht hguorht detcelloc secnalab tnuocca laredeF eht fo sronrevoG fo draoB eht yb derosnops yevrus weivretni na si FCS ehT .elbaliava era atad yevrus ot sraey eerht yreve ecno detcudnoc si tI .yrusaerT eht fo tnemtrapeD eht htiw noitarepooc ni metsyS evreseR rieht ,emocni rieht fo stnuoma dna secruos eht ,sdlohesuoh .S.U fo seitilibail dna stessa eht no noitamrofni tcelloc ataD .snalp tnemeriter dna htlaeh derosnops-reyolpme ni noitapicitrap dna ,tnemyolpme ,scitsiretcarahc cihpargomed -etavirp yb dna ,seicnega tnemnrevog rehto ,evreseR laredeF eht ta stsimonoce yb desu ylediw era FCS eht morf dna stessa fo noitubirtsid dna tnuoma eht ni sdnert yduts ot snoitutitsni cimedaca dna snoitazinagro hcraeser rotces hcraeseR rof noitazinagrO lanoitaN eht yb detcelloc neeb evah atad FCS ,2991 ecniS .sdlohesuoh .S.U gnoma seitilibail latot a gnitneserper ,FCS eht rof deweivretni erew sdlohesuoh 225,4 ,4002 nI .)CRON( ogacihC fo ytisrevinU eht ta .rorre gnitroper ot tcejbus si FCS eht ,syevrus dlohesuoh lla ekiL 8.sdlohesuoh .S.U noillim 1.211 fo According to the Survey of Consumer Finances, there were 84.7 million households with one or more workers in 2004 and in 44.5% of these households either the householder, the householder's spouse, or both participated in a defined contribution retirement plan.9 (See Table 2.) Some 6 For workers who are covered by a retirement plan at work, the tax deduction phases out between $75,000 and $85,000 of adjusted gross income for a married couple filing a joint return and between $50,000 and $60,000 of adjusted gross income for a single individual. 7 In 2007, unmarried workers can contribute to a Roth IRA if they have adjusted gross income of less than $110,000. Married couples can contribute to a Roth IRA if they have adjusted gross income of less than $160,000. Total combined contributions to both traditional IRAs and Roth IRAs cannot exceed $4,000 for workers under age 50 and $5,000 for workers age 50 and older. 8 This report refers to households rather than to families because, according to the researchers at the Federal Reserve Board, the unit of analysis in the SCF is more comparable to the Census Bureau's definition of a household than to its definition of a family. (For more information, see Bucks, Kennickell, and Moore, Federal Reserve Bulletin, 2006.) 9 There were 112.1 million households in the U.S. in 2004, and 84.7 million households (75.6%) in which either the householder or the householder's spouse was employed at the time the survey was conducted. We counted households as participating in the plan if the household, the employer, or both contributed to a plan. ¢ workers do not participate because their employer does not offer a plan; however, data from the Department of Labor indicate that among workers whose employer offers a DC plan, 20% do not participate.10 Participation in employer-sponsored defined contribution plans varied with the age and marital status of the householder. Participation was lowest among households in which the householder was under age 35 (37%) and highest among households in which the householder was between the ages of 45 and 54 (52%). Participation was higher among married-couple households (51%) than among unmarried householders (36%), partly because married-couple households had more workers. However, married-couple households had higher participation rates at all ages than households headed by unmarried persons. Table 2 also shows the percentage of participating households in which either the household, the employer, or both contribute to the plan. Ninety percent of participating households reported that they contributed to the plan in which they participated, while 83% reported that the employer contributed to the plan.11 Three-fourths of all participating households reported that both the household and the employer contributed to the plan. Age and marital status are both important considerations when evaluating the adequacy of a household's retirement savings. Couples obviously need more income to support themselves than single persons (although they do not necessarily need twice as much income.)12 Younger workers have more time to save than older workers, and can reap the benefits of compound interest over a longer period. As the data presented later in this report will demonstrate, workers who wait until middle age to start saving for retirement face an uphill struggle in accumulating adequate retirement assets. Table 3 shows the retirement account balances of households that owned one or more retirement accounts in 2004, categorized by the age and marital status of the household head. The first column shows the balances in all of the DC plans at the current main jobs of the householder and his or her spouse. The second column shows the balances in all retirement accounts owned by the household, including accounts at their current jobs, balances held in accounts at former employers, and balances in individual retirement accounts (IRAs). The third column of Table 3 shows the ratio of household retirement saving to annual household earnings. For example, the second row of Table 3 shows that among married-couple households in which the householder was under age 35, the median balance in all retirement accounts owned by the household was $19,000. This amount was equal to 26.7% of the median annual earnings of those households. Similar ratios are used later in this report to illustrate a measure of the adequacy of retirement savings. 10 See National Compensation Survey: Employee Benefits in Private Industry, U.S. Department of Labor, Bureau of Labor Statistics, Summary 06-05, August 2006. Some workers whose employer offers a plan may not be eligible to participate if they are under age 21, have less than one year of service, or work less than 1,000 hours in a year. 11 In any particular instance it is possible that only the household or the employer contributed to the plan. Assuming that each household answered the survey questions correctly, those that reported that the household did not contribute to the plan would be participating on the basis of employer contributions only. 12 In these tables, the householder is classified by his or her legal marital status at the time the interview was conducted. ¢ Table 3 also shows the 75th percentile and the 25th percentile retirement of account balances. At the 75th percentile, married couple households headed by persons under age 35 had total retirement assets of $44,000. In other words, three-fourths of married-couple households headed by persons under age 35 had total retirement assets of $44,000 or less in 2004, while one-fourth of all such households had total retirement assets of more than $44,000. At the 25th percentile, married couple households headed by persons under age 35 had total retirement assets of $5,400 in 2004. Among married-couple households headed by individuals between 45 and 54 years old, median retirement assets in 2004 were $103,200. Households headed by unmarried individuals had retirement assets that were lower at every age than those of married couples, both in absolute terms and as a ratio of their current earnings. Among households headed by single persons between the ages of 45 and 54, for example, median retirement assets in 2004 were $32,000, or less than a third of the median retirement assets of married-couple households in this age group. Likewise, at the 75th percentile, households headed by unmarried individuals between the ages of 45 and 54 had total retirement assets of $80,000, compared to assets of $275,000 among married couple households in this age group. At the 25th percentile, households headed by unmarried individuals between the ages of 45 and 54 had total retirement assets of $11,400, compared with assets of $30,000 among married couple households. Eventually, most households will have to begin spending their retirement assets. Most choose to do so through periodic withdrawals, while others choose to convert some or all of their retirement assets into a guaranteed stream of income by purchasing an annuity. An individual retiring at age 65 in January 2007 with $119,500--the median retirement account balance among married- couple households head by persons age 55 and older--could purchase a level, single-life annuity that would pay $826 per month ($9,912 per year) or a joint and 100% survivor annuity paying $662 per month ($7,944 per year), based on the current annuity interest rate of 5.25%.13 These amounts would replace just 19% and 15%, respectively, of the median household earnings of $52,000 among all married-couple households headed by individuals who were 60 to 64 years old in 2004.14 tnerruC ta snalP noitubirtnoC denifeD ni noitapicitraP dlohesuoH .2 elbaT 4002 ni reyolpmE :sdlohesuoh gnitapicitrap gnomA sdlohesuoH dlohesuoH htoB )s(reyolpmE dlohesuoH gnikrow htiw ni setapicitrap etubirtnoc ot etubirtnoc ot setubirtnoc aesuops ro daeh bnalp CD a nalp eht ot nalp eht nalp eht redlohesuoh fo egA 53 rednU 088,22 %6.63 %1.98 %0.58 %1.77 44 ot 53 106,12 6.94 6.88 0.38 5.37 45 ot 54 396,02 9.15 7.09 9.08 5.27 redlo ro 55 994,91 5.04 9.98 4.58 6.77 13 This is the interest rate on annuities issued by MetLife in January 2007. 14 Median household earnings in 2004 were calculated by CRS from Census Bureau data. 971. 000,41 000,01 elitnecrep ht52 435. 006,74 000,53 )naidem( elitnecrep ht05 001.1 000,511 000,28 elitnecrep ht57 44 ot 53 490. 004,5 007,4 elitnecrep ht52 762. 000,91 000,31 )naidem( elitnecrep ht05 515. 000,44$ 000,03$ elitnecrep ht57 53 rednU egA yb ,redlohesuoH deirraM sgninrae dlohesuoh adlohesuoh boj tnerruc launna ot sgnivas ni stnuocca ta snalp CD tnemeriter tnemeriter lla ni ecnalaB latot fo oitaR lla fo latoT 4002 ni secnalaB tnuoccA tnemeriteR dlohesuoH .3 elbaT .deirram reven ro ,detarapes ,decrovid ,dewodiw era ohw sredlohesuoh sedulcnI .c .krow ta nalp noitubirtnoc denifed a ni etapicitrap htob ro ,esuops s'redlohesuoh ,redlohesuoH .b .sdnasuoht ni ,rentrap/esuops deyolpme ro/dna redlohesuoh deyolpme na htiw sdlohesuoH .a .secnaniF remusnoC fo yevruS 4002 s'draoB evreseR laredeF eht fo sisylana SRC :ecruoS %9.47 %4.38 %6.98 %5.44 376,48 latoT 1.57 3.28 2.88 1.63 548,6 redlo ro 55 2.26 5.27 5.88 2.54 696,7 45 ot 54 1.27 6.18 1.88 9.63 170,9 44 ot 53 0.47 8.38 5.98 4.92 712,31 53 rednU credlohesuoh elgniS 7.87 7.68 7.09 8.24 456,21 redlo ro 55 5.77 0.58 7.19 9.55 899,21 45 ot 54 1.47 7.38 8.88 8.85 035,21 44 ot 53 8.97 0.68 8.88 5.64 366,9 53 rednU redlohesuoh deirraM credlohesuoh 6.07 0.08 6.88 8.53 828,63 elgniS redlohesuoh 2.77 2.58 1.09 3.15 548,74 deirraM sutats latiraM nalp eht ot nalp eht nalp eht bnalp CD a aesuops ro daeh etubirtnoc ot etubirtnoc ot setubirtnoc ni setapicitrap gnikrow htiw htoB )s(reyolpmE dlohesuoH dlohesuoH sdlohesuoH :sdlohesuoh gnitapicitrap gnomA ¢ contributions. The maximum permissible annual contributions by workers and employers are and employee have contributed to the plan and the investment gains or losses on those The amount that a household accumulates in a DC plan depends on the amount that the employer .sgniknar elitnecrep eht ni dedulcni era erom ro 1$ fo secnalab htiw stnuocca ylnO .)sARI( stnuocca tnemeriter laudividni dna sboj tsap dna tnerruc morf snalp noitubirtnoc denifed sedulcnI .a .secnaniF remusnoC fo yevruS 4002 eht fo sisylana ecivreS hcraeseR lanoissergnoC :ecruoS 704. 000,31 000,9 elitnecrep ht52 604.1 000,56 000,52 )naidem( elitnecrep ht05 177.3 000,671 000,521 elitnecrep ht57 redlo dna 55 232. 004,11 009,7 elitnecrep ht52 068. 000,23 000,42 )naidem( elitnecrep ht05 137.1 000,08 000,07 elitnecrep ht57 45 ot 54 121. 000,5 009,3 elitnecrep ht52 663. 000,41 009,21 )naidem( elitnecrep ht05 858. 000,04 000,92 elitnecrep ht57 44 ot 53 360. 005,2 000,2 elitnecrep ht52 351. 000,7 005,5 )naidem( elitnecrep ht05 423. 000,61$ 000,21$ elitnecrep ht57 53 rednU egA yb ,redlohesuoH elgniS 535. 000,53 000,21 elitnecrep ht52 555.1 005,911 000,94 )naidem( elitnecrep ht05 038.4 000,373 000,291 elitnecrep ht57 redlo dna 55 123. 000,03 000,02 elitnecrep ht52 798. 002,301 000,46 )naidem( elitnecrep ht05 42.2 000,572 000,681 elitnecrep ht57 45 ot 54 sgninrae dlohesuoh adlohesuoh boj tnerruc launna ot sgnivas ni stnuocca ta snalp CD tnemeriter tnemeriter lla ni ecnalaB latot fo oitaR lla fo latoT ¢ ¢ limited by federal law, but few workers contribute the legal maximum.15 In 2004, the maximum permissible employee contribution to defined contribution plans was the lesser of 100% of earnings or $13,000 per worker. Workers age 50 and older were permitted to contribute an additional $3,000. The maximum total contribution, including both employee and employer contributions, was $41,000 per worker in 2004. Table 4 shows the annualized dollar amount of contributions to defined contribution plans per household in 2004. Table 5 shows household contributions, employer contributions, and total contributions as a percentage of household earnings. In both tables, the first column of data shows the amount of household contributions, the second shows the amount of employer contributions, and the third column shows the total contribution to the plan. The employer and employee contributions do not sum to the total contribution because in some cases only the household contributed to the plan, and in other cases only the employer contributed.16 At each age, married-couple households contributed more to DC plans than households headed by unmarried persons. Among both married-couple households and single households and across all age groups, employee salary deferrals into defined contribution plans were larger than employer contributions. (See Table 4.) Among married-couple households headed by persons under 35, the median household contribution in 2004 was $3,680, and the median employer contribution was $2,520. The median total contribution was $5,520. Among households headed by unmarried persons under 35, the median household contribution in 2004 was $2,080, and the median employer contribution was $1,400. The median total contribution was $3,120. As a percentage of pay, the contributions of married-couple households and households headed by unmarried individuals differed less than the dollar amounts of their contributions. (See Table 5.) The median contribution among households headed by individuals under age 45 was about 5% for both single and married households. Both married-couple households and singles ages 45 to 54 typically contributed about 6% of earnings. Overall, household contributions ranged from about 3% of household earnings at the 25th percentile of contributions to about 10% of household earnings at the 75th percentile of contributions. 4 elbaT 4002 ni snalP derosnopS-reyolpmE ot snoitubirtnoC . )srallod 4002 ni( dlohesuoH reyolpmE latoT noitubirtnoc noitubirtnoc ot noitubirtnoc nalp CD ot nalp CD ot nalp CD egA yb ,redlohesuoH deirraM 53 rednU elitnecrep ht57 069,6$ 080,4$ 004,01$ 15 The maximum annual deferral into a DC plan is subject to I.R.C. §402(g). As established by P.L. 107-16, the maximum employee contribution under I.R.C. §402(g) is $15,500 in 2007 and is indexed in $500 increments. Workers age 50 and older can contribute an additional $5,000. Under I.R.C. §415(c), the limit on total annual additions to defined contribution plans--comprising the sum of employer and employee contributions--is $45,000 in 2007. The §415(c) limit is indexed in $1,000 increments. 16 Unlike the calculation of a mean, when calculating percentiles, zero values are excluded. Therefore, although the mean household contribution and mean employer contribution sum to the mean total contribution, the median household contribution and median employer contribution do not necessarily sum to the total median contribution. .detubirtnoc reyolpme eht ylno sesac rehto ni dna ,nalp eht ot detubirtnoc dlohesuoh eht ylno sesac emos ni esuaceb latot eht ot mus ton od snoitubirtnoc eeyolpme dna reyolpmE :etoN . secnaniF remusnoC fo yevruS 4002 eht fo sisylana ecivreS hcraeseR lanoissergnoC :ecruoS 003,2 080,1 008,1 elitnecrep ht52 067,5 040,2 002,4 )naidem( elitnecrep ht05 000,21 006,3 042,9 elitnecrep ht57 redlo dna 55 004,2 001,1 008,1 elitnecrep ht52 023,4 002,2 021,3 )naidem( elitnecrep ht05 004,8 008,3 004,5 elitnecrep ht57 45 ot 54 080,2 069 002,1 elitnecrep ht52 006,3 009,1 043,2 )naidem( elitnecrep ht05 067,6 083,3 006,3 elitnecrep ht57 44 ot 53 065,1 087 069 elitnecrep ht52 021,3 004,1 080,2 )naidem( elitnecrep ht05 046,5$ 025,2$ 069,3$ elitnecrep ht57 53 rednU egA yb ,redlohesuoH elgniS 046,3 023,1 082,2 elitnecrep ht52 068,7 000,3 004,5 )naidem( elitnecrep ht05 069,51 012,6 000,21 elitnecrep ht57 redlo dna 55 044,4 006,1 088,2 elitnecrep ht52 067,8 021,3 000,6 )naidem( elitnecrep ht05 007,41 044,6 004,11 elitnecrep ht57 45 ot 54 006,3 065,1 082,2 elitnecrep ht52 006,6 088,2 044,4 )naidem( elitnecrep ht05 061,31 005,5 008,8 elitnecrep ht57 44 ot 53 021,3 053,1 008,1 elitnecrep ht52 025,5 025,2 086,3 )naidem( elitnecrep ht05 nalp CD nalp CD ot nalp CD ot ot noitubirtnoc noitubirtnoc noitubirtnoc latoT reyolpmE dlohesuoH ¢ 8.91 5.7 1.31 elitnecrep ht 57 redlo dna 55 1.6 1.3 0.4 elitnecrep ht52 0.01 0.5 0.6 )naidem( elitnecrep ht05 9.41 3.7 1.01 elitnecrep ht57 45 ot 54 9.5 4.2 0.4 elitnecrep ht52 7.9 9.4 5.5 )naidem( elitnecrep ht05 7.21 0.7 1.8 elitnecrep ht57 44 ot 53 7.4 2.2 0.3 elitnecrep ht52 4.7 4.3 7.4 )naidem( elitnecrep ht05 %5.11 %1.5 %7.7 elitnecrep ht57 53 rednU egA yb ,redlohesuoH elgniS 0.6 3.2 8.3 elitnecrep ht52 2.01 0.4 7.6 )naidem( elitnecrep ht05 8.51 1.6 4.01 elitnecrep ht57 redlo dna 55 1.6 4.2 0.4 elitnecrep ht52 1.9 7.3 2.6 )naidem( elitnecrep ht05 8.31 9.5 4.9 elitnecrep ht57 45 ot 54 2.5 3.2 1.3 elitnecrep ht52 4.8 6.3 3.5 )naidem( elitnecrep ht05 2.21 0.6 3.8 elitnecrep ht57 44 ot 53 8.4 0.2 9.2 elitnecrep ht52 1.8 1.3 1.5 )naidem( elitnecrep ht05 %8.31 %1.5 %3.9 elitnecrep ht57 53 rednU egA yb ,redlohesuoH deirraM nalp CD ot nalp CD ot nalp CD ot noitubirtnoc noitubirtnoc noitubirtnoc latoT reyolpmE dlohesuoH )sgninrae dlohesuoh fo egatnec rep a sa( 4002 ni snalP derosnopS-reyolpmE ot snoitubirtnoC . 5 elbaT ¢ ¢ dlohesuoH reyolpmE latoT noitubirtnoc noitubirtnoc noitubirtnoc nalp CD ot nalp CD ot nalp CD ot )naidem( elitnecrep ht05 7.9 1.4 2.31 elitnecrep ht52 9.4 0.3 1.7 secnaniF remusnoC fo yevruS 4002 eht fo sisylana ecivreS hcraeseR lanoissergnoC :ecruoS . dlohesuoh eht ylno sesac emos ni esuaceb latot eht ot mus ton od snoitubirtnoc eeyolpme dna reyolpmE :etoN .detubirtnoc reyolpme eht ylno sesac rehto ni dna ,nalp eht ot detubirtnoc ¢ The previous section described the amounts that households had accumulated in retirement savings accounts and how much they were contributing to their retirement plans in 2004, as reported in the Federal Reserve Board's Survey of Consumer Finances. This section uses income data from the Census Bureau's Current Population Survey and statistical software that simulates the variability of investment rates of return to estimate future retirement account balances and to demonstrate how several variables can affect the amount of retirement savings that households could accumulate by age 65.17 As was shown by the data displayed in Table 2, only 45% of working households participated in employer-sponsored defined contribution plans in 2004. Some households that did not participate in employer-sponsored plans saved for retirement in individual retirement accounts (IRAs), but data from the SCF indicate that most households that did not participate in an employer- sponsored plan also did not own an IRA.18 Households that do not save for retirement may be reducing their future incomes significantly, but by how much? If a household starts to save, what variables might affect the amount that they have accumulated by the time the householder reaches age 65? These questions are addressed in this section of the report. As noted in the introduction, workers must decide not only whether to save for retirement, but also how much to save, how to invest their savings, and what to do with their accumulated savings each time they change jobs and when they reach retirement. A number of variables can affect the amount that households have accumulated in their retirement accounts by the time they reach retirement age, including the following:19 · household earnings; · the amount that the household saves; 17 The CPS rather than the SCF was used as the source of earnings because its much larger sample size (more than 70,000 households) allowed us to estimate household earnings among married-couple and unmarried householders by individual year of age rather than in age groups. Our estimates of future retirement accumulations are based on annual contributions as a percentage of earnings. Therefore, the SCF asset data were not needed. 18 According to the 2004 SCF, 38.8 million households had balances in DC plans in 2004, 32.6 million households owned an IRA, and 15.0 million had both a DC plan and an IRA. Of 73.3 million U.S. households that did not own a DC plan from current or past employment in 2004, only 17.6 million (24.0%) owned an IRA. (CRS Report RL30922, Retirement Savings and Household Wealth: Trends from 2001 to 2004, by Patrick Purcell.) 19 Households may have wealth other than retirement accounts, including other financial assets and/or a home that they own. This report focuses on retirement savings accounts. ¢ · the age at which the householder begins to save, and thus the number of years over which contributions and investment earnings accumulate; and · the average annual rate of return earned by the household's retirement account. To estimate household savings, household earnings also had to be estimated. For the base year of our analysis, earnings were estimated in 2004 at every age from 25 through 64 for married-couple and unmarried households at the 75th, 50th, and 25th percentiles of earnings from the March 2005 CPS. This produced an age-earnings-marital status matrix with 240 cells. (See Appendix Table A-1.) For each later year in the simulation, earnings were increased by 1.1%, which is the estimated long-run growth rate of real wages as projected by the Office of the Actuary of the Social Security Administration. For example, the median earnings in 2004 of a married-couple household headed by a 25 year-old was $41,000. To estimate the same household's earnings one year later when the householder would be age 26, the 2004 median earnings of married-couple households headed by a 26-year-old ($45,600) were multiplied by 1.011, which resulted in estimated household earnings of $46,102. The following year, when the householder would be age 27, we estimated household earnings as $51,106, which is the 2004 earnings of a married- couple household headed by a 27 year-old, ($50,000) multiplied by 1.0112. The process for each household through age 64 was repeated. For simplicity, we assumed that married-couple households would remain married-couple households throughout the period of the analysis and that unmarried households would remain unmarried. Having estimated household earnings each year, we next had to choose the percentage of earnings that each household would contribute to its retirement account annually. The data on contribution rates from the 2004 Survey of Consumer Finances indicated that most households contribute between 3% and 10% of earnings to their employer-sponsored retirement plan. Based on these data, we estimated the retirement savings that would accumulate by age 65, assuming that households contributed either 6%, 8%, or 10% of household earnings to the account every year, starting at age 25, age 35, or age 45.20 Assuming the householder retires at age 65, these starting dates would result in periods of saving for retirement lasting 40 years, 30 years, and 20 years, respectively. Households that do not save every year would accumulate less than was estimated for those that contribute consistently. To estimate the amount that households would have accumulated in their retirement account by age 65, the annual rate of return on the funds invested in those accounts had to be estimated. Rather than assume that the rate of return in each year would be the long-term average rate of return on a mixed portfolio of stocks and bonds, we used a Monte Carlo simulation process in which the rate of return in each year was randomly selected from the range of likely rates of return implied by the historical returns on stocks and bonds. Many financial advisors recommend that investors shift their portfolios away from stocks and into bonds as they approach retirement. Therefore, in our simulations, households allocated 65% of assets to the Standard & Poor's 500 index of stocks from the ages of 25 to 34, 60% to stocks from 35 to 44, 55% to stocks from 45 to 54, and 50% to stocks after age 55. In each case, the remainder of the portfolio was assumed to be invested in AAA-rated corporate bonds. The accounts were re-balanced after each year of the 20 The amounts represent the total annual contribution to the plan, as a percentage of earnings. We do not differentiate between worker contributions and employer contributions. "median earners" and "low earners," respectively. status as "high earners," and to those with earnings at the 50th and 25th earnings percentiles as of return. Referred to are households with earnings at the 75th percentile for their age and marital based on several different contribution rates, lengths of investment period, and investment rates by married-couple households and unmarried householders with high, medium, and low earnings, Figures 1 through 4 illustrates the likely range of retirement savings that would be accumulated .ksir rof ecnarelot rieht no gnidneped ,erofeb gnivas neeb dah yeht naht ssel ro erom evas ot esoohc thgim dlohesuoh a ,semoctuo fo egnar ylekil eht tuoba noitamrofni siht htiW .%1.21 dna %5.1 neewteb eb lliw doirep taht revo nruter fo etar laer launna egareva eht taht ytilibaborp %09 a dna ,%8.6 fo doirep raey-04 nevig yna revo skcots nommoc no nruter fo etar laer egareva launna detcepxe na ylpmi stluser eseht ,ksir gnitaulave fo smret nI .erom ro %1.21 saw doirep raey-04 eht revo nruter fo etar laer naem eht ,snoitareti 000,5 eht fo %5 ni ,emertxe rehto eht ta elihw ,ssel ro %5.1 saw doirep raey-04 eht revo nruter fo etar laer naem eht ,snoitareti 000,5 esoht fo %5 ni ,revewoH )860.1 = 30.1/01.1( .5002 hguorht 6291 morf doirep eht ni skcots nommoc no nruter fo etar laer naem lautca eht sa emas eht si hcihw ,%8.6 saw )semit 000,5 doirep raey-04 a gnitalumis( snoitareti 000,5 ni nruter fo etar laer naem eht ,skcots nommoc ni detsevni erew stessa fo %001 hcihw ni doirep raey-04 a fo noitalumis ruo nI .selitnecrep yb deknar neht era--nruter fo setar tnemtsevni ,esac siht ni--noitalumis eht fo stluser ehT .detalumis neeb evah sdoirep tnemtsevni raey-04 fo sdnasuoht dna ,detelpmoc si noitalumis eht litnu detaeper si ssecorp ehT .nruter fo setar fo noitubirtsid ytilibaborp eht morf raey hcae rof nruter fo etar a gnitareneg niaga ,emit dnoces a doirep raey-04 eht setalumis neht margorp ehT .atad lacirotsih morf devired sa ,nruter fo setar elbaborp fo noitubirtsid eht no desab raey hcae rof nruter fo etar a setareneg erawtfos noitalumis olraC etnoM ,elpmaxe rof ,doirep raey-04 a revo eveihca dluow tnemtsevni na taht nruter fo etar ylekil eht etamitse oT ).nruter fo setar launna swohs 2-A elbaT xidneppA( .%1.7 saw egareva siht dnuora noitaived dradnats eht ,5002 dna 6291 neewteb %3.6 degareva sdnob etaroproc detar-AAA no nruter launna lanimon eht elihw ,esiwekiL .%7.91 fo noitaived dradnats a gnicudorp ,egareva siht dnuora ylediw deirav nruter fo setar launna tub ,5002 dna 6291 neewteb %0.01 degareva skcots fo xedni 005 s'rooP & dradnatS eht no nruter fo etar lanimon ehT .raey ot raey morf yrav tekram kcots eht ni nruter fo setar ,elpmaxe roF .egareva eht dnuora seulav fo noitubirtsid eht osla tub ,elbairav modnar a fo eulav egareva eht tsuj ton ezilitu sdohtem noitamitse olraC etnoM .ksir fo tnemele eht setamitse ruo otni etaroprocni ot su wolla noitamitse fo sdohtem olraC etnoM ,sdrow rehto nI .egareva eht woleb ro evoba yltnacifingis era taht stluser fo doohilekil eht osla tub ",egareva no" rucco lliw taht tluser eht tsuj ton etamitse nac ew ,sdohtem olraC etnoM gnisU .ecnerrucco sti fo doohilekil eht ot gnidrocca emoctuo hcae knar neht dna ,ecnairav dna naem lacitamehtam sti ot gnidrocca yrav ot elbairav modnar eht gniwolla ,semit ynam tneve na etalumis ot si ssecorp noitamitse olraC etnoM a fo ecnesse ehT .tnuocca tnemeriter a ni etalumucca lliw srekrow taht tnuoma eht tceffa nac nruter fo setar tnemtsevni fo ytilibairav eht woh etartsulli ot si snoitalumis olraC etnoM fo esu nommoc enO .olraC etnoM fo sonisac eht ni deyalp ecnahc fo semag eht gniyduts ot sisylana ytilibaborp denekil ohw s0491 eht ni snaicitamehtam yb denioc saw mret ehT .modnar era emoctuo eht gnitceffa selbairav eht fo erom ro eno hcihw ni tneve na fo emoctuo elbaborp eht gnitamitse fo dohtem a si sisylana olraC etnoM ¢ and bonds. The model also takes into account the correlation between stock and bond returns. simulation so that the portfolio would start the next year at the chosen allocation between stocks ¢ ¢ ¢ Figure 1 illustrates how the variability of investment rates of return can affect the amount of retirement assets that households accumulate. In this example, we estimated the value of a retirement account balance at age 65 for a married-couple household with median earnings that, beginning at age 35, contributed 8% of earnings each year for 30 years to an account that was invested in a mix of stocks and bonds. Each of the 1,000 simulations of a 30-year investment period produced a unique mean rate of return for the 30-year period. Of these, the median real rate of return over the 30-year period was 5.5% At this rate of return, the household's retirement account balance (in 2004 dollars) would be $468,000 when the householder reached age 65. sgnivaS tnemeriteR no nruteR fo setaR tnemtsevnI ni ytilibairaV fo tceffE .1 erugiF 56 egA ta $1,100,000 $961,000 $1,000,000 $900,000 Retirement savings, in 2004 dollars $800,000 $700,000 $600,000 $468,000 $500,000 $400,000 $300,000 $214,000 $200,000 $100,000 $0 5th percentile of returns 50th percentile of returns 95th percentile of returns Investment rate of return (percentile rank) .ecivreS hcraeseR lanoissergnoC :ecruoS fo %8 setubirtnoc taht sgninrae naidem htiw dlohesuoh elpuoc-deirram a fo 56 ega ta sgnivas tnemeriteR :etoN .nruter fo etar tnemtsevni yb ,53 ega ta gninnigeb sraey 03 rof yllaunna yap Figure 1 also shows what this household would accumulate in its retirement account if the average rate of return over the 30-year investment period was significantly higher than average or lower than average. Based on the history of stock and bond returns from 1926 through 2005, and given the allocation of investment assets that we chose, there is a 5% chance that the household's retirement account would earn an average annual real rate of return of 1.7% or less over the 30- year investment period. The historical record of returns suggests that such a low rate of return has approximately a one-in-twenty chance of occurring in any given 30-year period. In the event that investment returns were at the 5th percentile, the household would have $214,000 (in 2004 dollars) in its retirement account when the householder reached age 65. This is less than half of ¢ the amount that it would have accumulated if the average rate of return over the 30-year period were equal to the median real rate of return of 5.5%. On the other hand, stock and bond markets might perform better-than-average over the period when the household is saving for retirement, in which case it will accumulate more assets than it would have in a period of average investment returns. Based on historical returns, in any 30-year investment period, there is a 95% probability that the average real rate of return on the mix of assets in the household's retirement account would be 9.3% or less. However, there is a 5% chance that average real rate of return would be higher than 9.3%. If the household were to attain a 9.3% average real rate of return on its investments over 30 years, it would have a retirement account balance of $961,000 (in 2004 dollars) at age 65. The amounts displayed in Figure 1 illustrate that variability in rates of return will inevitably lead to some uncertainty in retirement planning. Households can decide when to begin saving for retirement and how much to save, but variability in rates of return is beyond their control and yet has a great impact on their assets at retirement. The age at which a worker starts saving for retirement can dramatically affect the amount that he or she has accumulated at retirement age. Beginning to save at a younger age results in larger total contributions and allows investment gains to compound over a longer time. Figure 2 shows the retirement account balance at age 65 of a married-couple with median household earnings that contributes 8% of pay each year to a retirement account invested in a mix of stocks and bonds over periods of 20, 30, and 40 years. The household that begins saving at age 25 saves for 40 years, while the households that begin saving at ages 35 and 45 save for 30 years and 20 years, respectively. For each of the three investment periods, we show the account balance at age 65 if the average rate of return for the investment period were equal to the median rate of return, and if the average rate of return were significantly below the median (at the 5th percentile of likely rates of return) or significantly above the median (at the 95th percentile of likely rates of return). If the couple were to begin saving at age 25 and earned the median rate of return over 40 years, their account balance at age 65 would be $844,000 (in 2004 dollars). Delaying the start of retirement saving until age 35 would result in an account balance of $468,000, or just 55% of the amount they would have accumulated had they started saving at age 25. Waiting until age 45 to begin saving for retirement would result in an account balance of $213,000 at 65, or one-fourth of the amount they would have had at 65 if they had contributed 8% a year starting at age 25. Of course, a couple that delays the start of saving until age 45 might get lucky and invest during a period of above-average rates of return. For example, if rates of return during the twenty years when they were saving were in the 95th percentile of the likely rates of return, the couple would accumulate $372,000 (in 2004 dollars) by age 65, or about 75% more than if rates of return during that period were at the 50th percentile. On the other hand, even a couple that begins to save at age 25 may have the misfortune to invest during a period of below-average returns. A couple with median household earnings that contributes an amount equal to 8% of earnings annually for 40 years to a retirement account that is invested in a mix of stocks and bonds could expect to accumulate $844,000 (in 2004 dollars) by age 65 if investment returns over that period were in the 50th percentile of likely returns, but they would have just $370,000 if investment returns were at the 5th percentile of likely rates of return. Workers cannot control the variability of investment rates of return, but they can choose to begin saving while they are young. As the data presented in ¢ Figure 2 demonstrate, this usually will lead to much greater wealth at retirement than they could achieve if they were to wait until 35 or 45 to begin saving. 56 egA ta sgnivaS tnemeriteR no snigeB sgnivaS hcihW ta egA fo tceffE .2 erugiF .ecivreS hcraeseR lanoissergnoC :ecruoS fo %8 setubirtnoc taht sgninrae naidem htiw dlohesuoh elpuoc-deirram a fo 56 ega ta sgnivas tnemeriteR :etoN .nruter fo etar tnemtsevni dna snigeb gnivas hcihw ta ega yb ,53 ega ta gninnigeb yllaunna sgninrae Figure 3 illustrates the effect of contribution rates on retirement savings. A married-couple household that contributed 6% of household earnings each year to a retirement account invested in a mix of stocks and bonds starting at age 35 would accumulate $353,000 (in 2004 dollars) by age 65 if the real rate of return over that period were at the 50th percentile of likely rates of return. By contributing 8% of earnings, the household would have $468,000 by age 65, or 33% more than if they had contributed 6% of pay to their account. Had the couple contributed 10% per year for 30 years, their account balance at age 65 would be $594,000, or 68% higher than the amount resulting from a 6% annual contribution. Variation in rates of return can affect retirement accumulations significantly, even for those who contribute a greater amount to their retirement account. For example, the results displayed in Figure 3 show that if the average real rate of return over 30 years were in the 5th percentile of likely rates of return, a couple that contributed 6% of pay annually to a retirement account invested in a mix of stocks and bonds could expect to have accumulated just $170,000 (in 2004 dollars) by age 65. This is less than a quarter of the amount that they would have accumulated if rates of return during that period had been at the 95th percentile. Similarly, with returns at the 5th percentile, a couple contributing 10% of earnings annually will have accumulated $301,000 by age 65, or about half of what they would have accumulated at the median rate of return, and only ¢ a quarter of the $1.2 million that would have accumulated if rates of return were at the 95th percentile of likely rates of return. 3 erugiF 56 egA ta sgnivaS tnemeriteR no etaR noitubirtnoC launnA fo tceffE . $1,400,000 Retirement savings, in 2004 dollars $1,219,000 $1,200,000 $961,000 $1,000,000 $762,000 $800,000 $594,000 $600,000 $468,000 $353,000 $400,000 $301,000 $170,000 $214,000 $200,000 $- 6% 8% 10% Total annual contribution as a percentage of household earnings 5th percentile of returns 50th percentile of returns 95th percentile of returns .ecivreS hcraeseR lanoissergnoC :ecruoS 03 rof setubirtnoc taht sgninrae naidem htiw dlohesuoh elpuoc-deirram a fo 56 ega ta sgnivas tnemeriteR :etoN .nruter fo etar tnemtsevni dna noitubirtnoc launna yb ,53 ega ta gninnigeb sraey Figure 4 shows account balances at age 65 (in 2004 dollars) for married couples at three different earnings levels, assuming that they contributed 8% of earnings each year beginning at age 35 to a retirement account invested in a mix of stocks and bonds. A married-couple household with median earnings would have accumulated $468,000 (in 2004 dollars) by age 65 if stock and bond market returns were at the median during the 30-year investment period. A high-earning household with earnings at the 75th percentile would have accumulated $706,000 dollars, while a low-earning household with earnings at the 25th percentile would have accumulated just $289,000. ¢ 4 erugiF 56 egA ta sgnivaS tnemeriteR no sgninraE dlohesuoH fo tceffE . .ecivreS hcraeseR lanoissergnoC :ecruoS sgninrae dlohesuoh fo %8 setubirtnoc taht dlohesuoh elpuoc-deirram a fo 56 ega ta sgnivas tnemeriteR :etoN .nruter fo etar tnemtsevni dna sgninrae dlohesuoh launna yb ,53 ega ta gninnigeb sraey 03 rof ¢ For most people, the main purpose of saving for retirement is to have money available to replace the earnings that they will lose when they stop working. The proverbial "three-legged stool" of retirement income--private pensions, Social Security, and personal savings--is missing a leg for many households because the number of defined benefit pensions has declined substantially over the past 25 years. Most workers in the U.S.--about 96%--are covered by Social Security, but Social Security is not designed to replace all of a worker's earnings.21 The Social Security Administration estimates that for a career-long average-wage earner retiring at the full retirement age, Social Security will replace about 41% of their career-average earnings. For a career-long low-wage earner, Social Security will replace an estimated 55% of average earnings. For a career- long high-wage earner, Social Security will replace just 27% of their average earnings. The percentage of pre-retirement earnings that is replaced by Social Security, pensions, or other income is called the earnings replacement rate. The estimated value of retirement accounts at age 65 in constant 2004 dollars is an absolute measure of retirement assets. The earnings replacement rate is a relative measure of retirement assets. To calculate earnings replacement rates, we first needed to decide on an appropriate measure of earnings. For most households, a relevant measure would be their average earnings in the years just before they reach retirement age. As our measure 21 Most workers not covered by Social Security are employees of state and local governments that have elected not to participate. These governments are required to provide them with pensions. About one-fourth of state and local workers are not in Social Security. ¢ of pre-retirement earnings, we used average household earnings of married-couple and single- person households headed by persons 60 to 64 years old. We used average earnings in 2004 as reported on the CPS for households headed by persons 60 to 64 years old as the base measure of earnings, and projected these amounts forward at a growth rate of 1.1% per year. To calculate the earnings replacement rate from households' retirement savings, we converted the account balance into a stream of income. This was done by calculating the annuity value of the retirement account. An annuity is a contract between an individual and a financial institution-- usually an insurance company--in which, in exchange for a premium paid by the annuity purchaser, the insurer promises to pay the individual an income for life or for a fixed period of years. The premium for an "immediate income" annuity is usually a single payment, which the insurer then invests. A life annuity insures the purchaser (and his or her surviving spouse in the case of a joint and survivor annuity) against longevity risk, which is the risk that the individual will outlive his or her retirement assets. We calculated the percentage of pre-retirement earnings that would be replaced if the household's entire retirement account balance were converted to a life annuity.22 For example, if a married-couple household with median earnings contributed an amount equal to 8% of earnings to a retirement account each year for 30 years and earned the median rate of return over that period of time, the couple would have accumulated $468,000 (in 2004 dollars) when the householder reached age 65. In January 2007, this amount would purchase a joint and 100% survivor annuity that would replace 42% of the household's average annual earnings in the five years before the householder reached age 65.23 (On the CPS, income is reported before taxes. The replacement rate here is pre-tax annuity income divided by pre-tax earnings.) ¢ ksir eht ecaf tnuocca tnemeriter a ni htlaew tnemeriter rieht fo klub eht htiw ega tnemeriter hcaer ohw srekroW tsniaga noitcetorp edivorp seitiunna emocnI .stessa rieht eviltuo yam yeht ,ylkciuq oot yenom wardhtiw yeht fi taht erofeb eid lliw sresahcrup ytiunna emoS .ytiunna na sesahcrup ohw enoyreve fo ksir ytilatrom eht gniloop yb ksir siht regnol evil ohw esoht ot emocni gniyap fo rerusni eht ot stsoc eht stesffo hcihw ,ycnatcepxe efil lamron rieht gnihcaer ro sih dna resahcrup eht gnol woh rettam on ,emocni deetnaraug a gnireffo etipseD .ycnatcepxe efil lamron rieht naht .llams ylevitaler sniamer setatS detinU eht ni seitiunna emocni rof tekram eht ,evil yam esuops derusni reh gnisahcrup taht si tekram ytiunna eht fo htworg wols eht rof nosaer enO ?ralupop erom seitiunna emocni t'nera yhW ylimaf dna htlaeh doog fo esuaceb ,ohw elpoep yb desahcrup eb ot dnet seitiunna ,tsriF .sksir tuohtiw ton si ytiunna na efil egareva-naht-regnol evah ot dnet sresahcrup ytiunna esuaceB .egareva naht regnol evil ot tcepxe ,yrotsih modnar a erew sresahcrup ytiunna fi eb dluow yeht naht rehgih era taht smuimerp egrahc tsum srerusni ,ycnatcepxe ohw elpoep fo ycnatcepxe-efil regnol eht ot gnidrocca decirp era seitiunna esuaceB .noitalupop eht fo noitces-ssorc eht ,dnoceS .laed doog a ton si ytiunna na taht dnif yam ycnatcepxe efil egareva htiw nosrep a ,meht yub yllautca evah ,ecnesse ni ,lliw muimerp ytiunna eht esac hcihw ni ,stcepxe ehs ro eh naht reilrae eid dluoc resahcrup ytiunna rovivrus dna tnioj sa hcus ,ksir siht ecuder taht seitiunna fo sepyt ynam era erehT .rerusni eht ot detiefrof neeb 22 We defined pre-retirement earnings as average household earnings in the five years before the householder reached age 65. For most households, earnings peak when the householder is between 50 and 60 years old. Also, the annuity values are based on converting the entire account balance to an annuity, and thus illustrate the maximum replacement rate that could be achieved from converting the household's retirement account to an annuity. 23 The annuity values were calculated on http://www.immediateannuities.com. For married couples, they represent the income from a level, joint and 100% survivor annuity for a couple in which the husband is age 65 and the wife is age 62. For unmarried households, they represent the income from a level, single-life annuity for a male householder who is 65 years old. An annuity purchased by a woman age 65 with the same account balance would provide a smaller annual income because women have longer life expectancies than men. ¢ eht gnirud syap ytiunna eht taht emocni eht secuder seetnaraug eseht fo hcae tub ,seitiunna niatrec-mret dna seitiunna .resahcrup eht fo efil ehT .efil rof tnuoma ylhtnom dexif a syap ytiunna level A .noitalfni tsniaga noitcetorp detimil ylno reffo seitiunna tsoM dedarG .noitcetorp noitalfni laitrap reffo seitiunna emoS .esir secirp sa emit revo senilced ytiunna eht fo eulav laer laitini rellams a yap yeht tub ,raey hcae--%3 yllacipyt--egatnecrep dexif a yb tnemyap ylhtnom eht esaercni seitiunna won srerusni emoS .ytiunna eht ni esaercni egatnecrep deetnaraug eht sdeecxe noitalfni fi eulav esol osla dna tnuoma na gniyub ni ksir rehtonA .dlos neeb evah wef dna evisnepxe yrev era yeht tub ,seitiunna dexedni-noitalfni reffo htiw dlohesuoh a evael dluoc rerusni na ot stessa tnemeriter s'eno fo noitroporp laitnatsbus a pu gnivig taht si ytiunna .sesnepxe erac mret-gnol ro stsoc lacidem sa hcus ,esira yam taht sesnepxe egral yna rof yap ot secruoser etauqedani tnemeriter a ni htlaew tnemeriter rieht fo tsom evah ohw elpoep taht erussa pleh dluoc seitiunna efil morf stifeneB erom gnicudni tub ,ytrevop raen ro ni sraey retal rieht dneps dna eid yeht erofeb stessa rieht tsuahxe ton od tnuocca .srerusni ynam rof egnellahc a sniamer seitiunna emocni esahcrup ot elpoep Figures 1 through 4 illustrate how variation in rates of return, length of investment period, contribution rates, and household income can affect the amount of retirement savings that households have accumulated by age 65. Figure 5 combines in a single graph the effect that variation in investment rate of return, length of investment period, and contribution rates can have on earnings replacement rates for a married-couple household with median household earnings. In this graph, the value of the household's retirement account at age 65 (measured in 2004 dollars) has been converted to a joint and 100% survivor annuity, and the income from the annuity is compared with average household earnings over the five years before retirement. On the vertical axis, the graph shows the annuity value of the household's retirement account, measured as the percentage of average pre-retirement earnings the annuity would replace. On the horizontal axis, we show three investment periods of 20, 30, and 40 years, which correspond in our analysis to saving for retirement starting at ages 45, 35, and 25, respectively. The vertical bars show the range of replacement rates that could be achieved from converting the household's retirement account to a joint and 100% survivor annuity at age 65, depending on the percentage of pay that the household contributed to its account each year and the investment rate of return. On each bar, the replacement rates corresponding to low, average, and high rates of return are represented by the square, circle, and diamond, respectively. For example, the left-most (and shortest) vertical bar in Figure 5 shows that if a married couple with median earnings invested 6% of household earnings for 20 years, their retirement account balance at age 65 could purchase an annuity that would pay an amount equal to just 8% of their final average pay, assuming that investment returns over the 20-year period were in the 5th percentile of likely returns. The annuity value of their account would replace 14% of their final average earnings if investment returns were at the median, and the annuity would replace 27% of their final average pay if investment returns over the 20-year period were in the 95th percentile of likely returns. Moving from left to right across Figure 5, the vertical bars representing earnings replacement rates both begin and end at higher replacement rates, representing the effects on retirement savings of higher contribution rates and longer investment periods. The greater length of the bars as contribution rates rise and investment periods grow longer illustrates the impact that variability of rates of return can have on retirement account accumulations, and in turn on the annuity income that one could purchase with those accounts. Looking at the left-most panel, we see that if a household were to begin saving 8% of earnings at age 45, the annuity value of its retirement account could vary by more than 20 percentage points, depending on whether the real rate of return in the period is significantly above average (at the 95th percentile of returns) or ¢ significantly below average (at the 5th percentile of returns.) After a 20-year period of high investment returns, a median-earning couple saving 8% of earnings per year would have a retirement account balance that, if converted to an annuity, could replace 33% of its average pre- retirement earnings. If investment returns during that period are significantly below average, however, the annuity value of their retirement account would replace just 11% of the couple's pre-retirement average earnings. The longer the investment period, the greater the difference in retirement accumulations that results from the variability of returns. After a 40-year period of high investment returns (at the 95th percentile of likely returns), a median-earning couple saving 8% of earnings per year would have a retirement account balance that, if converted to an annuity, could replace 180% of its average pre-retirement household earnings. In other words, if they converted their entire retirement account to an annuity, the income would be almost twice their average household earnings in the five years preceding retirement. If investment returns during that period were significantly below average (at the 5th percentile of likely returns), the annuity value of their retirement account would replace only about one-third of the couple's pre-retirement average earnings. The account balance that a household would accumulate over 40 years of investing during a period of below-average returns would be much less than the amount that the couple would have accumulated if they'd had the good fortune to have invested during a period of above-average rates of return. Nevertheless, in our simulations the annuity value of an account accumulated by contributing 8% of earnings over 40 years of very low investment returns was almost the same as the annuity value of an account accumulated by contributing 8% of earnings over a 20-year period of well above-average investment returns. Workers who begin to save at a young age can accumulate substantial retirement assets even in periods of low returns, and they will be far better off at retirement than those who delay saving in the event that investment returns are at or above the historical average. ¢ 5 erugiF -deirraM a rof 56 egA ta setaR tnemecalpeR sgninraE fo egnaR detamitsE . sgninraE naideM htiw dlohesuoH elpuoC .ecivreS hcraeseR lanoissergnoC :ecruoS The data presented in Figures 1 through 5 illustrate account balances for married-couple households at age 65 under specific assumptions about the age at which savings begin, annual contribution rates, investment rates of return, and household earnings. Figure 6 compares the accumulated retirement savings at age 65 (in 2004 dollars) of married-couple households and unmarried householders with median earnings who contribute 8% of earnings beginning at age 35 to a retirement account invested in a mix of stocks and bonds. Account balances are higher for ¢ married couples because their higher earnings produce larger contributions, but as the data presented in Figure 7 demonstrate, if the couple purchases a joint and 100% survivor annuity, their earnings replacement rate would be lower than that of an unmarried householder purchasing a single-life annuity.24 If, over a 30-year investment period, total rates of return on stocks and bonds were at their historical median, a married-couple with median earnings that contributed 8% of pay annually to a retirement plan invested in a mix of stocks and bonds could accumulate an estimated $468,000 (in 2004 dollars) by age 65. This is almost twice as much as the estimated $247,000 that would be accumulated by an unmarried householder with median earnings contributing 8% of pay to a retirement account over the same period. Nevertheless, the annuity value of the retirement account, expressed as a percentage of pre-retirement earnings, would be higher for the unmarried householder than for the married-couple household. (See Figure 7.) The higher earnings replacement rate for the unmarried householders is due largely to the fact that in these examples, the annuity estimates are based on a joint and 100% survivor annuity for the married-couple household and a single-life annuity for the unmarried householder. If the married-couple household elected to purchase an annuity without a survivor benefit (i.e., a single-life annuity based on the age of the householder), their annuity income would be higher during the life of the annuity purchasers, but the surviving spouse would no longer receive annuity income after the death of the annuity purchaser. 6 erugiF dna elpuoC deirraM ro 56 egA ta sgnivaS tnemeriteR detamitsE . sredlohesuoH deirramnU .ecivreS hcraeseR lanoissergnoC :ecruoS ohw sgninrae dlohesuoh naidem htiw selgnis dna selpuoc deirram fo 56 ega ta sgnivas tnemeriteR :etoN .nruter fo etar tnemtsevni yb ,sraey 03 rof sgninrae dlohesuoh fo %8 etubirtnoc 24 Married-couple households have higher earnings than unmarried households mainly because they are more likely to have multiple earners. ¢ 7 erugiF deirramnU dna selpuoC deirraM fo 56 egA ta setaR tnemecalpeR sgninraE . sredlohesuoH 1.20 Earnings replacement rate 1.02 1.00 0.85 0.80 0.60 0.50 0.42 0.40 0.19 0.23 0.20 0.00 Married Single Marital status of householder 5th percentile of returns 50th percentile of returns 95th percentile of returns .ecivreS hcraeseR lanoissergnoC :ecruoS ohw sgninrae dlohesuoh naidem htiw selgnis dna selpuoc deirram fo 56 ega ta etar tnemecalper sgninraE :etoN .nruter fo etar tnemtsevni yb ,sraey 03 rof sgninrae dlohesuoh fo %8 etubirtnoc Table 6 displays the estimated retirement account balances (in 2004 dollars) at age 65 for households that contribute an amount equal to 8% of household earnings to a retirement account for periods of 40 years (beginning at age 25), 30 years (beginning at age 35), and 20 years (beginning at age 45). Retirement account accumulations are shown both for married-couple households and unmarried householders with high, median, and low career-average earnings. These earnings levels are represented by households with earnings at the 75th percentile, 50th percentile, and 25th percentile among households of the same age and marital status. Similar tables showing retirement account balances resulting from contributions equal to 6% of earnings and 10% of earnings are shown in the Appendix to this report. (See Table A-3 and Table A-4.) For each of six types of household, as defined by household earnings and the marital status of the householder, Table 6 shows the estimated retirement account balance at age 65 resulting from annual contributions equal to 8% of pay over periods of 20, 30, and 40 years, depending upon whether the average real rate of return on investment during that period was at the 95th, 50th, or 5th percentile of likely returns. For example, a median-earning married-couple household that began contributing 8% of pay annually at age 35 to a retirement account invested in a mix of stocks and bonds could expect, on average, to have accumulated $468,000 (in 2004 dollars) in its retirement account by age 65. This is the amount that would result if investment returns over those 40 years fell in the middle--the 50th percentile--of the likely range of possible returns, based on the distribution of real rates of total return on stocks and bonds that occurred between 1926 and 2005. If rates of return over the investment period were well above average--at the 95th percentile of likely returns--the household's estimated retirement account balance at age 65 would be $961,000 (in 2004 dollars). ¢ On the other hand, if the average rate of return earned over the investment period was well below average--at the 5th percentile of likely rates of return--the household would have accumulated just $214,000 (in 2004 dollars) by age 65. Table 6 also displays two relative measures of retirement savings: the ratio of the account balance to the household's average earnings in the five years before the householder reached age 65 and the annuity value of the retirement account balance at age 65. For example, the estimated retirement account balance at age 65 of $468,000 (in 2004 dollars) for a median-earning married- couple household that contributed 8% of pay annually to a retirement account over 40 years beginning at age 25 would be equal to 7.0 times the household's average earnings (in 2004 dollars) during the five years when the householder was ages 60 to 64. Based on current interest rates, if this amount were converted to a level, joint and 100% survivor annuity, it would replace an estimated 42% of the household's average earnings in the five years that the householder was ages 60 to 64. In our simulations, given an annual retirement plan contribution equal to 8% of earnings, the ratio of account balances at age 65 to household earnings from ages 60 to 64 ranged from a low of 1.4 times earnings for low-earning married-couple and unmarried households that begin to save at age 45 and invest during a period of low investment returns to a high of 31times earnings for a high-earning unmarried householder who begins saving at age 25 and invests during a period of high investment returns. Replacement rates ranged from a low of 10% for low- earning married-couple households and 12% for low-earning unmarried households who invest in a period of below-average returns to 202% for high-earning married-couple households and 257% for high-earning unmarried households who invest in a period of above-average returns. iteR .6 elbaT latoT launnA no desaB ,setaR tnemecalpeR emocnI dna sgnivaS tnemer sgninraE dlohesuoH fo %8 ot lauqE snoitubirtnoC )srallod 4002 ni stnuoma( redlohesuoh deirraM redlohesuoh deirramnU sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA 57 ht ht05 ht52 ht57 ht05 ht52 elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep )gnivas fo sraey 04( 52 ega ta gnivas snigeb dlohesuoH ht59 snruter fo elitnecrep ecnalab tnuoccA 000,799,2 000,520,2 000,762,1 000,088,1 000,481,1 000,896 5 laniF/sgnivaS 5.32 1.72 4.03 8.62 7.82 0.13 yap .gva sgninraE 65.1 08.1 20.2 22.2 83.2 75.2 tnemecalper etar ht05 snruter fo elitnecrep ecnalab tnuoccA 000,952,1 000,448 000,625 000,277 000,484 000,582 5 laniF/sgnivaS 9.9 3.11 6.21 0.11 8.11 7.21 yap .gva sgninraE 66.0 57.0 48.0 19.0 89.0 50.1 tnemecalper etar 000,56 000,111 000,971 000,821 000,312 000,623 ecnalab tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 24.0 93.0 73.0 63.0 33.0 92.0 sgninraE yap .gva 0.5 7.4 4.4 4.5 0.5 4.4 5 laniF/sgnivaS 000,311 000,491 000,013 000,422 000,273 000,565 ecnalab tnuoccA snruter fo elitnecrep ht59 )gnivas fo sraey 02( 54 ega ta gnivas snigeb dlohesuoH etar tnemecalper 42.0 32.0 22.0 12.0 91.0 71.0 sgninraE yap .gva 9.2 7.2 6.2 1.3 9.2 6.2 5 laniF/sgnivaS 000,66 000,311 000,281 000,031 000,412 000,723 ecnalab tnuoccA snruter fo elitnecrep ht5 etar tnemecalper 35.0 05.0 74.0 64.0 24.0 73.0 sgninraE yap .gva 4.6 0.6 7.5 9.6 3.6 5.5 5 laniF/sgnivaS 000,541 000,742 000,793 000,982 000,864 000,607 ecnalab tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 90.1 20.1 69.0 59.0 58.0 57.0 sgninraE yap .gva 2.31 3.21 6.11 3.41 9.21 3.11 5 laniF/sgnivaS 000,792 000,705 000,318 000,895 000,169 000,044,1 ecnalab tnuoccA snruter fo elitnecrep ht59 )gnivas fo sraey 03( 53 ega ta gnivas snigeb dlohesuoH etar tnemecalper 54.0 34.0 93.0 63.0 33.0 92.0 sgninraE yap .gva 4.5 1.5 7.4 5.5 9.4 4.4 5 laniF/sgnivaS 000,221 000,802 000,333 000,822 000,073 000,555 ecnalab tnuoccA snruter fo elitnecrep ht5 elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep ht52 ht05 ht57 ht52 ht05 ht57 sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA redlohesuoh deirramnU redlohesuoh deirraM ¢ ¢ redlohesuoh deirraM redlohesuoh deirramnU sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA ht52 ht05 ht57 ht52 ht05 ht57 elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep 5 laniF/sgnivaS 6.2 9.2 1.3 5.2 7.2 9.2 yap .gva sgninraE 71.0 91.0 02.0 12.0 22.0 42.0 tnemecalper etar ht5 snruter fo elitnecrep ecnalab tnuoccA 000,581 000,911 000,07 000,101 000,26 000,63 5 laniF/sgnivaS 4.1 6.1 7.1 4.1 5.1 6.1 yap .gva sgninraE 01.0 11.0 11.0 21.0 31.0 31.0 tnemecalper etar .ecivreS hcraeseR lanoissergnoC :ecruoS ¢ The uncertain future of Social Security and the declining prevalence of defined-benefit pensions that provide a guaranteed lifelong income have put much of the responsibility for preparing for retirement directly on workers. Saving for retirement will be especially important for workers who are not included in a defined-benefit pension where they are employed, which includes about 80% of all workers in the private sector. Even among those who are saving for retirement, retirement account balances are generally low when compared to household earnings. As the data displayed in Table 3 showed, the median account balance in 2004 among married-couple households headed by persons 55 to 64 years old was equal to just 1.6 times the median earnings of those households. Among unmarried householders between the ages of 55 and 64, median retirement savings were equal to just 1.4 times median earnings. The low rate of personal saving in the United States and the lack of any retirement savings accounts among millions of American households indicate that there is a need for greater awareness among the public about the importance of setting aside funds to prepare for life after they have stopped working. Most workers in the United States will need to begin saving more of their income if they wish to maintain a standard of living in retirement comparable to that which they enjoyed while working. The alternatives would be to work longer or to greatly reduce their standard of living in retirement. Employers in the United States are not required to offer pensions to their employees and workers are not required to save for retirement. Because both of these activities are voluntary, most policy proposals for boosting workers' retirement saving are intended to make workers more aware of the importance of saving and to make the act of saving easier for both workers and employers. Although most defined contribution plans continue to require employees to elect to participate, a growing number of plans have adopted automatic enrollment of eligible workers, and the Pension Protection Act of 2006 (P.L. 109-280) included provisions intended to encourage more employers ¢ to adopt automatic enrollment in their retirement plans.25 Another option to boost retirement saving would be to promote greater use of payroll deduction for individual retirement accounts (IRAs). Because IRAs are not employer-sponsored plans, there would be little administrative burden for employers, and payroll deduction would be an easy way for workers to send money directly to a retirement account.26 The Pension Protection Act also made permanent the Retirement Savings Tax Credit, originally enacted in 2001, and provided for indexing the income thresholds over which the credit is phased out. Some policy analysts have suggested that if this credit were made refundable, it would encourage more lower-income workers to save for retirement.27 Another proposal would disregard amounts in retirement savings plans for purposes of determining eligibility for certain means- tested federal aid programs. On the employer side, it has been proposed to give employers a tax credit for the cost of maintaining retirement savings plans to encourage more employers to offer such plans. With respect to promoting secure lifetime income for retirees, policy proposals have focused on providing incentives for people to purchase life annuities. For example, under one proposal, individuals would not pay federal taxes on one-half of the income generated by annuities that promise lifetime payments. There would be an annual limit of $20,000 on the amount of annuity income that an individual could exclude from federal taxes each year. Another policy option would be to require employers that offer defined contribution plans to offer retiring workers the opportunity to purchase an annuity through the employer, as is currently required of defined benefit plans. Are Americans saving adequately for retirement? There is no simple answer to this question because circumstances vary so greatly from one household to another. Data from the Federal Reserve Board's Survey of Consumer Finances indicate that fewer than half of all working households participated in an employer-sponsored retirement savings plan in 2004, and fewer than a third of all working households owned an individual retirement account. For this report, we estimated the amounts that married-couple households and unmarried householders with high, medium, and low earnings could accumulate in their retirement accounts by age 65, depending on the percentage of earnings that they save, the age at which they begin saving, and the total real rate of return in stock and bond markets during the period that they are investing. Two of these three variables--the contribution rate and the age at which they begin to save--are more or less under the control of the worker. As the results displayed in Figure 5 illustrate, starting to save while young and doing so consistently every year is perhaps the single most effective way to assure that one reaches retirement with adequate savings. For a household with median annual earnings, even a relatively 25 See CRS Report RS21954, Automatic Enrollment in 401(k) Plans, by Patrick Purcell. The PPA also allows taxpayers to instruct the IRS to direct a portion of their income tax refund into an IRA. 26 See "Pursuing Universal Retirement Security Through Automatic IRAs," joint written statement of David C. John and J. Mark Iwry, testimony before Subcommittee on Long-Term Growth and Debt Reduction, Committee on Finance, United States Senate, June 29, 2006. http://www.senate.gov/~finance/hearings/testimony/2005test/062906testdjmi.pdf. 27 See CRS Report RS21795, The Retirement Savings Tax Credit: A Fact Sheet, by Patrick Purcell. ¢ low annual contribution equal to 6% of earnings will, at the median likely rate of return, grow over 40 years to an amount that, if converted to an annuity, would replace more than half of the household's average pre-retirement earnings. At a 10% contribution rate, the annuity value of the account would replace more than 90% of the household's pre-retirement earnings, assuming rates of return are at the median. It is also important to note that our estimates are based on the assumption that the household contributes to a retirement plan every year for a period of 20, 30, or 40 years. Because of interruptions in employment, unexpected expenses, and other reasons, many households do not contribute to a retirement plan every year. Unfortunately, we cannot safely assume that rates of return over the next 20, 30, or 40 years will be "average." In our analysis, we simulated the variability in rates of return through a Monte Carlo process. We found that, although the average annual rate of total return over 30 years on the mixed portfolio of stocks and bonds that we chose for our analysis would be 5.5%, there was a 5% chance that the real rate of return would be 1.7% or lower and a 5% chance that it would be 9.3% or higher. This variability in rates of return is something over which workers have no control, and which will inevitably lead to some uncertainty in retirement planning. While it may be easier for workers to focus on what they are likely to accumulate in their retirement accounts "on average," ignoring the variability of investment rates of return could lead to poor decisions that might be avoided if workers were better informed about the way that variability in investment rates of return can affect their retirement savings over time. A worker who is told that the most likely real rate of return on his or her investments is 5.5% might save more or less than if he or she were told that the most likely real rate of return will be between 1.7% and 9.3%. Both statements are true, but the second more clearly conveys the uncertainty that characterizes any estimate of likely future rates of return on investment. 000,91 000,43 000,45 000,04 000,96 000,301 55 000,91 000,53 000,85 000,24 005,37 009,211 45 000,42 000,73 000,26 039,44 008,27 000,901 35 000,32 000,83 000,46 029,44 000,37 000,501 25 068,12 000,73 007,55 447,14 000,07 000,501 15 000,02 000,53 000,06 000,84 000,57 004,901 05 000,12 000,63 000,65 002,64 009,37 000,501 94 000,22 000,73 000,36 000,54 000,37 000,111 84 000,12 000,04 000,16 000,74 000,47 449,801 74 512,32 000,04 000,06 000,44 000,07 008,101 64 000,22 000,73 000,75 004,24 002,17 005,901 54 000,02 000,53 000,85 000,54 000,37 000,901 44 000,12 009,43 000,55 000,44 012,96 000,501 34 000,22 000,63 069,55 000,24 099,86 059,201 24 000,22 000,63 000,55 000,24 000,56 000,79 14 005,22 000,73 000,06 004,54 000,07 000,001 04 000,02 781,43 088,65 000,24 000,56 000,001 93 000,02 000,73 008,85 000,24 002,76 000,001 83 000,02 000,53 000,65 044,93 000,56 004,59 73 000,22 000,63 000,06 000,24 000,66 000,59 63 000,02 000,53 000,55 000,24 005,36 000,59 53 000,12 000,53 000,55 000,83 008,06 000,09 43 000,02 000,23 000,45 000,73 000,06 000,09 33 000,02 000,53 000,45 000,53 005,95 000,78 23 000,02 000,43 000,55 000,43 000,55 000,68 13 000,22 000,53 000,55 005,73 002,85 000,28 03 009,22 000,53 000,55 000,43 000,25 000,87 92 000,02 000,63 001,55 051,43 000,45 006,57 82 000,02 000,53 000,65 000,23 000,05 000,37 72 000,02 000,53 487,25 000,03 006,54 004,36 62 002,91$ 000,33$ 000,25$ 172,72$ 000,14$ 005,06$ 52 elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep egA ht52 ht05 ht57 ht52 ht05 ht57 redlohesuoH deirramnU redlohesuoH deirraM sgninraE fo knaR elitnecreP dna redlohesuoH fo sutatS latiraM dna egA yb ,4002 ni sgninraE dlohesuoH .1-A elbaT ¡ ¢ %1.1 %9.02 %6.81 6891 %1.81 %6.2 %7.5- 6491 %8.3 %5.92 %7.13 5891 %2.2 %5.3 %1.73 5491 %9.3 %1.71 %3.6 4891 %3.2 %1.3 %6.91 4491 %8.3 %3.7 %5.22 3891 %0.3 %4.3 %9.62 3491 %8.3 %9.43 %5.12 2891 %0.9 %1.3 %7.61 2491 %9.8 %0.9 %9.4- 1891 %9.9 %8.1 %6.01- 1491 %5.21 %0.5- %4.23 0891 %7.0 %5.4 %5.7- 0491 %3.31 %6.1- %6.81 9791 %0.0 %3.4 %6.1 9391 %0.9 %8.1 %6.6 8791 %8.2- %4.4 %6.72 8391 %7.6 %5.5 %1.7- 7791 %9.2 %6.2 %2.33- 7391 %9.4 %6.41 %0.42 6791 %4.1 %2.6 %9.13 6391 %9.6 %0.11 %2.73 5791 %0.3 %9.6 %8.24 5391 %3.21 %2.0 %5.62- 4791 %5.1 %7.9 %0.3 4391 %7.8 %0.3 %7.41- 3791 %8.0 %3.5 %5.65 3391 %4.3 %3.8 %0.91 2791 %3.01- %2.21 %6.7- 2391 %3.3 %7.9 %3.41 1791 %3.9- %4.2- %2.54- 1391 %6.5 %2.11 %9.3 0791 %4.6- %3.6 %4.72- 0391 %2.6 %5.2- %4.8- 9691 %6.0 %3.4 %8.01- 9291 %7.4 %5.22 %1.11 8691 %2.1- %4.3 %0.93 8291 %0.3 %2.1- %0.42 7691 %3.2- %6.6 %6.33 7291 %5.3 %3.0- %1.01- 6691 %1.1- %3.6 %6.8 6291 U-IPC sdnoB 005 P&S raeY U-IPC sdnoB 005 P&S raeY AAA AAA 5002-6291 ,xednI ecirP remusnoC eht ni egnahC fo etaR launnA dna sdnoB dna skcotS no nruteR latoT launnA .2-A elbaT .yevruS noitalupoP tnerruC 5002 hcraM eht fo sisylana ecivreS hcraeseR lanoissergnoC :ecruoS 008,21 000,62 000,44 338,22 809,14 000,37 46 000,31 000,52 000,64 000,62 000,44 000,58 36 272,41 000,82 000,05 000,82 000,55 000,88 26 000,71 000,82 000,44 000,33 000,55 000,49 16 000,91 000,23 005,25 000,13 005,65 000,09 06 000,02 003,23 006,15 000,63 884,85 000,001 95 000,02 756,23 000,65 000,23 619,36 000,201 85 008,02 000,63 000,65 000,04 000,66 811,501 75 000,32 000,53 000,25 000,73 000,56 000,001 65 elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep egA ht52 ht05 ht57 ht52 ht05 ht 57 redlohesuoH deirramnU redlohesuoH deirraM ¢ yap .gva 4.22 8.02 4.91 8.12 4.91 8.61 5 laniF/sgnivaS ecnalab 000,305$ 000,658$ 000,753,1$ 000,019$ 000744,1$ 000,141,2$ tnuoccA snruter fo elitnecrep ht59 )gnivas fo sraey 04( 52 ega ta gnivas snigeb dlohesuoH elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep ht52 ht05 ht57 ht52 ht05 ht 57 sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA redlohesuoh deirramnU redlohesuoh deirraM )srallod 4002 ni stnuoma( sgninraE dlohesuoH fo %6 ot lauqE snoitubirtnoC latoT launnA no desaB ,setaR tnemecalpeR emocnI dna sgnivaS tnemeriteR .3-A elbaT .secruos suoirav morf delipmoc ,ecivreS hcraeseR lanoissergnoC :ecruoS %3.4 %1.7 %7.91 :noitaived dradnatS %0.3 %3.6 %0.01 :5002 ot 6291 ,egareva launnA %7.4 %8.7 %9.4 5002 %9.1 %1.2 %5.21 5691 %5.2 %5.6 %9.01 4002 %0.1 %0.4 %5.61 4691 %3.2 %2.9 %7.82 3002 %6.1 %2.3 %8.22 3691 %5.1 %2.11 %1.22- 2002 %3.1 %2.6 %7.8- 2691 %6.2 %5.11 %9.11- 1002 %7.0 %7.3 %9.62 1691 %5.3 %7.11 %1.9- 0002 %4.1 %7.6 %5.0 0691 %6.2 %0.3- %0.12 9991 %7.1 %2.0 %0.21 9591 %5.1 %9.01 %6.82 8991 %8.1 %9.0 %3.34 8591 %2.2 %9.01 %3.33 7991 %9.2 %5.4 %9.9- 7591 %8.2 %2.4 %9.22 6991 %0.3 %8.1- %8.9 6591 %5.2 %0.22 %5.73 5991 %4.0 %1.1 %5.42 5591 %7.2 %4.2- %3.1 4991 %7.0- %7.4 %0.94 4591 %7.2 %7.41 %1.01 3991 %7.0 %1.2 %4.1 3591 %9.2 %6.01 %6.7 2991 %8.0 %4.3 %8.31 2591 %1.3 %9.51 %4.03 1991 %0.6 %2.0- %4.02 1591 %1.6 %6.8 %1.3- 0991 %9.5 %9.1 %9.92 0591 %6.4 %3.51 %6.13 9891 %1.2- %3.4 %4.02 9491 %4.4 %8.31 %5.61 8891 %0.3 %7.3 %5.2 8491 %4.4 %6.1- %3.5 7891 %8.8 %5.0 %6.3 7491 U-IPC sdnoB 005 P&S raeY U-IPC sdnoB 005 P&S raeY AAA AAA ¢ yap .gva 3.2 2.2 1.2 5.2 3.2 0.2 5 laniF/sgnivaS ecnalab 000,25 000,09 000,441 000,401 000,071 000,062 tnuoccA snruter fo elitnecrep ht5 etar tnemecalper 04.0 73.0 53.0 53.0 13.0 82.0 sgninraE yap .gva 8.4 5.4 3.4 2.5 7.4 2.4 5 laniF/sgnivaS ecnalab 000,901 000,681 000,992 000,812 000,353 000,335 tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 38.0 77.0 37.0 27.0 56.0 75.0 sgninraE yap .gva 0.01 3.9 8.8 9.01 7.9 5.8 5 laniF/sgnivaS ecnalab 000,522 000,483 000,716 000,354 000,627 000,480,1 tnuoccA snruter fo elitnecrep ht59 )gnivas fo sraey 03( 53 ega ta gnivas snigeb dlohesuoH etar tnemecalper 43.0 23.0 03.0 82.0 52.0 22.0 sgninraE yap .gva 1.4 8.3 6.3 2.4 8.3 3.3 5 laniF/sgnivaS ecnalab 000,39 000,951 000,352 000,471 000,282 000,624 tnuoccA snruter fo elitnecrep ht5 etar tnemecalper 77.0 27.0 76.0 26.0 65.0 94.0 sgninraE yap .gva 3.9 7.8 1.8 3.9 4.8 3.7 5 laniF/sgnivaS ecnalab 000,012 000,753 000,965 000,983 000,526 000,239 tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 58.1 27.1 16.1 54.1 92.1 21.1 sgninraE elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep ht52 ht05 ht57 ht52 ht05 ht 57 sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA redlohesuoh deirramnU redlohesuoh deirraM ¢ )gnivas fo sraey 04( 52 ega ta gnivas snigeb dlohesuoH elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep ht52 ht05 ht57 ht 52 ht05 ht57 sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA redlohesuoh deirramnU redlohesuoh deirraM )srallod 4002 ni stnuoma( sgninraE dlohesuoH fo %01 ot lauqE snoitubirtnoC latoT launnA no desaB ,setaR tnemecalpeR emocnI dna sgnivaS tnemeriteR .4-A elbaT .ecivreS hcraeseR lanoissergnoC :ecruoS etar tnemecalper 11.0 01.0 90.0 90.0 80.0 70.0 sgninraE yap .gva 3.1 2.1 1.1 3.1 2.1 1.1 5 laniF/sgnivaS ecnalab 000,82 000,94 000,97 000,55 000,39 000,441 tnuoccA snruter fo elitnecrep ht5 etar tnemecalper 81.0 71.0 61.0 51.0 41.0 31.0 sgninraE yap .gva 2.2 0.2 9.1 3.2 1.2 9.1 5 laniF/sgnivaS ecnalab 000,84 000,38 000,431 000,59 000,951 000,442 tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 43.0 23.0 03.0 92.0 72.0 42.0 sgninraE yap .gva 1.4 8.3 6.3 3.4 0.4 6.3 5 laniF/sgnivaS ecnalab 000,19 000,751 000,152 000,181 000,103 000,854 tnuoccA snruter fo elitnecrep ht59 )gnivas fo sraey 02( 54 ega ta gnivas snigeb dlohesuoH etar tnemecalper 91.0 81.0 71.0 71.0 51.0 41.0 sgninraE elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep ht52 ht05 ht57 ht52 ht05 ht57 sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA redlohesuoh deirramnU redlohesuoh deirraM ¢ )gnivas fo sraey 02( 54 ega ta gnivas snigeb dlohesuoH etar tnemecalper 43.0 23.0 03.0 92.0 72.0 42.0 sgninraE yap 1.4 9.3 7.3 4.4 0.4 6.3 .gva 5 laniF/sgnivaS 000,39 000,951 000,652 000,481 000,103 000,954 ecnalab tnuoccA snruter fo elitnecrep ht5 etar tnemecalper 76.0 36.0 95.0 85.0 35.0 74.0 sgninraE yap 1.8 6.7 2.7 8.8 0.8 0.7 .gva 5 laniF/sgnivaS 000,381 000,213 000,205 000,563 000,495 000,798 ecnalab tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 93.1 03.1 22.1 12.1 80.1 59.0 sgninraE yap 7.61 6.51 7.41 3.81 3.61 3.41 .gva 5 laniF/sgnivaS 000,773 000,446 000,330,1 000,167 000,912,1 000,228,1 ecnalab tnuoccA snruter fo elitnecrep ht59 )gnivas fo sraey 03( 53 ega ta gnivas snigeb dlohesuoH etar tnemecalper 45.0 15.0 84.0 44.0 04.0 53.0 sgninraE yap 6.6 1.6 7.5 6.6 0.6 3.5 .gva 5 laniF/sgnivaS 000,841 000,152 000,204 000,472 000,544 000,276 ecnalab tnuoccA snruter fo elitnecrep ht5 etar tnemecalper 13.1 12.1 41.1 30.1 29.0 08.0 sgninraE yap 7.51 6.41 7.31 5.51 9.31 1.21 .gva 5 laniF/sgnivaS 000,453 000,306 000,069 000,546 000,630,1 000,245,1 ecnalab tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 40.3 28.2 11.2 93.2 21.2 38.1 sgninraE yap 7.63 0.43 7.13 0.63 9.13 6.72 .gva 5 laniF/sgnivaS 000,528 000,004,1 000,322,2 000,105,1 000,183,2 000,615,3 ecnalab tnuoccA snruter fo elitnecrep ht59 elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep ht52 ht05 ht57 52 ht 05 ht ht57 sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA redlohesuoh deirramnU redlohesuoh deirraM ¢ ppurcell@crs.loc.gov, 7-7571 Specialist in Income Security Debra B. Whitman Patrick Purcell .ecivreS hcraeseR lanoissergnoC :ecruoS etar tnemecalper 71.0 61.0 51.0 41.0 31.0 21.0 sgninraE yap 1.2 9.1 8.1 1.2 0.2 8.1 .gva 5 laniF/sgnivaS 000,64 000,97 000,921 000,98 000,151 000,432 ecnalab tnuoccA snruter fo elitnecrep ht5 etar tnemecalper 03.0 82.0 72.0 52.0 42.0 12.0 sgninraE yap 6.3 4.3 2.3 8.3 6.3 2.3 .gva 5 laniF/sgnivaS 000,18 000,041 000,522 000,061 000,762 000,014 ecnalab tnuoccA snruter fo elitnecrep ht05 etar tnemecalper 35.0 05.0 74.0 54.0 24.0 83.0 sgninraE yap 4.6 0.6 6.5 8.6 3.6 7.5 .gva 5 laniF/sgnivaS 000,441 000,742 000,593 000,582 000,474 000,127 ecnalab tnuoccA snruter fo elitnecrep ht59 elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep elitnecrep ht52 ht05 ht57 ht52 05 ht ht57 sgninrae dlohesuoh launnA sgninrae dlohesuoh launnA redlohesuoh deirramnU redlohesuoh deirraM ¢ ------------------------------------------------------------------------------ For other versions of this document, see http://wikileaks.org/wiki/CRS-RL33845