Is There Really a Retirement-Savings Crisis?

Two experts look at the same data—and come to very different conclusions

The population is aging, Social Security’s trust funds are expected to be depleted in 2034, and the median household headed by someone age 55 to 64 has little more than $100,000 in retirement savings.

But are large numbers of Americans facing a retirement crisis? Will they suffer a substantial drop in their standard of living in later life?

Experts, it turns out, are sharply divided on the answer to this key question.

To shed light on the topic, The Wall Street Journal invited two prominent economists to share their thoughts, and differences, in an exchange of emails. Alicia Munnell, director of Boston College’s Center for Retirement Research, argues that the outlook is alarming. Andrew Biggs, resident scholar at the nonprofit American Enterprise Institute, contends that most Americans are doing just fine.

The two of them, friends and past collaborators, “have read the same literature and looked at the same data” but have come to very different conclusions, observes Ms.. Munnell. Here’s an edited transcript of their conversation.

Do we or don’t we?

WSJ: Do we face a retirement crisis?

MS. MUNNELL: Yes. Our National Retirement Risk Index [the NRRI], based on data from the U.S. Federal Reserve’s Survey of Consumer Finances, shows that about half of today’s working-age households won’t be able to maintain their preretirement standard of living in retirement. The reason is simple: We need more income because we are living longer and continue to retire relatively early. But we will get less from traditional sources. And interest rates, which determine how much income we can draw from our nest eggs, have fallen to historic lows.

Under current law, Social Security replacement rates are being gradually reduced as the age at which you can claim full benefits rises from 65, for those born before 1938, to 67, for those born after 1959. Because Social Security faces a long-term deficit, benefits could be cut further.

In addition, traditional pensions are rapidly disappearing. While 401(k) plans could be an effective replacement if employers automatically enroll employees at high savings rates, today these plans are clearly falling short. For households nearing retirement that have 401(k)s but not necessarily IRAs, the typical total balance in their retirement savings is only $111,000.

Even worse, only about half of private-sector workers participate in any kind of employer plan at their current job. This coverage gap is a serious problem, because—outside of workplace plans—Americans save virtually nothing.

WSJ: Andrew, what’s your take?

MR. BIGGS: A “retirement crisis” is when inadequate savings cause large numbers of households to face a substantial drop in their standard of living in retirement. That is not going to happen.

Yes, some studies show most Americans falling short. But others show fewer Americans falling short, and smaller shortfalls.

Seniors have the lowest poverty rates in the population. Three-quarters of retirees tell Gallup they have enough to live comfortably. There is no evidence that retirees are cutting discretionary spending like entertainment or charitable contributions, which you’d expect if they were running short of money.

In addition, more working-age Americans are saving for retirement than in the past. While people are wistful for traditional pensions, never more than 40% of workers ever had one. Today, the Social Security Administration finds that 61% of all workers, and 80% of married couples, are saving in a retirement plan. Most households who should be saving for retirement are saving.

Federal Reserve data show that from 1981 to 2016, the total balances of 401(k)s, traditional pensions, IRAs and other retirement plans rose to 153% of GDP from 58%. Yes, some Americans are undersaving. But a crisis? If we didn’t have one in 1981, when savings were one-third the current level, we don’t have one today.

WSJ: Alicia, are a significant number of people likely to fall substantially short?

MS. MUNNELL: Yes. To be considered “at risk,” households in the NRRI must fall at least 10% short of their target. And many of the “at risk” households fall much further short.

Different assumptions

WSJ: Why do economists come to different conclusions?

MS. MUNNELL: The answer lies in two key assumptions. First, the NRRI assumes that people buy an annuity when they retire, so that they can spend a steady amount each year—less on vacations, more on health care. But economists who believe we do not face as big of a crisis generally assume that retirees plan to gradually spend less as they age. Their models also assume that parents do not spend more on themselves when their children leave the nest. Instead, they simply save the extra.

When we incorporate those assumptions in the NRRI, we get the same answer: No retirement problem. Which assumptions are right?

We have done two studies that conclude that parents do not save more when the children leave. Instead, they splurge a bit on themselves. And while it is true that spending declines as people age, this pattern may simply track declining income rather than an actual preference. We think our assumptions more accurately reflect households’ behavior and preferences.

MR. BIGGS: It is well-known that retirees’ spending declines as they age. On average, a college-educated married couple spends about 30% less at age 85 than at 65. Most retirees aren’t even spending their full incomes.

Why? As retirees gradually slow down, they seem to derive less enjoyment from big-ticket items like vacations or new cars. By itself, this could reduce retirement-saving needs by 10% to 25%.

The second question concerns children. Parents spend about $17,000 a year raising just one child, leaving them less to spend on themselves. But this lower preretirement standard of living means that parents don’t need to save as much to maintain that standard of living in retirement.

On average, a household with two children reaches retirement with about 10% less savings than a similar childless couple. So are children bad for your retirement security? When the University of Michigan’s Health and Retirement Study asks retirees about their financial security, retired parents don’t express any greater concerns than similar childless households.

Studies that take these patterns into account find that about three-quarters of Americans are saving enough. Just as important, households who are undersaving aren’t falling short by much. I guesstimate that about a 10% shortfall is typical. That turns the “retirement crisis” into a much more manageable problem.

WSJ: Is retirement security likely to worsen as the baby boomers retire?

MR. BIGGS: That’s not the trend so far. Retirees’ real incomes rose by 58% from 1984 to 2007, due to rising benefits from private retirement plans like 401(k)s. Yes, life expectancy for a 65-year-old rose by 2.7 years since 1990. But over the same period the average age of retirement rose by 2.1 years and total retirement savings grew by 82%, according to Federal Reserve data.

Are there challenges ahead? Sure. But the retirement crisis is more something we read about than actually see.

Still, without reform, Social Security’s trust funds will run out of money around 2030, after which benefits would be cut across-the-board by about 25%. If that happens, we truly would face a retirement crisis.

MS. MUNNELL: The retirement outlook is clearly getting worse. The most convincing argument is that the ratio of wealth to income has remained virtually unchanged at each age from 1983 through 2013, according to the Federal Reserve’s Survey of Consumer Finances. A “virtually unchanged” ratio may sound comforting, but it is actually alarming because people should be saving more. First, people are living longer and spending more time in retirement—three years longer for the average man. Second, we face high and rising health-care costs. Third, interest rates have declined, making it harder for retirees to earn income on the bonds many invest in.

Fourth, Social Security benefits have become less generous—which should also cause people to save more. Because they are not included in the Fed’s data, this means overall retirement security has actually declined. Last, the shift away from traditional pension plans—which are not included in the Fed’s data—to 401(k)-type plans—which are included—should have caused the reported wealth-to-income ratio to rise, but it did not.

In the face of these developments, the stability of wealth-to-income ratios strongly suggests declining retirement security. Younger baby boomers and the generations that follow will be even more vulnerable if Social Security is cut.

Most at risk

WSJ: What segments of the population are most at risk of having inadequate retirement income?

MS. MUNNELL: People in many segments of the population may find it difficult to be fully prepared. But, clearly, middle- and lower-income households are most at risk. Take the impact of Social Security’s progressive benefit formula on the lower-paid. Social Security replaces 40% of preretirement income for the average earner retiring at age 66. But for low earners the benchmark replacement rate is 55%. Still, because many low earners retire at 62, when they first become eligible to claim benefits, they see their benefits reduced to 44% and because few have a 401(k), their income drops substantially in retirement.

Now consider the average earner. While they have a 40% replacement rate, many also tend to claim a reduced early benefit. In 2013—the latest year for which complete data are available—middle-income households had a mere $100,000 in 401(k)s and IRAs—a sum that generates less than $400 a month. As a result, more than half of middle-income households could fall short.

MR. BIGGS: New research from economists at the Investment Company Institute and the IRS shows that the median retiree age 66 to 72 had an income equal to 96% of their after-tax income just before retirement. Typical replacement rates for the poor are even higher.

But medians don’t mean everyone has saved enough. One-quarter of retirees in the IRS data had a replacement rate below 72%; one-tenth were below 50%. Many of those under-savers are in the top two income quintiles and shouldn’t be government’s top priority.

But government should help the rest. For example, while researchers at the Rand Corp. find that 90% of college-educated married couples are well-prepared for retirement, only 29% of single women without a high-school diploma are well-prepared for retirement. This group is too poor to save much in 401(k)s, and many even lack the work history to qualify for Social Security benefits.

What do we do?

WSJ: What are your policy recommendations?

MR. BIGGS: Social Security reform needs to better protect the poor while gradually reducing benefits for middle- and upper-income households.

My solution is a universal, flat-dollar Social Security benefit set at the poverty line, like the system in New Zealand. The poorest third of retirees would receive a benefit increase, and poverty in old age would virtually disappear. On top of that, each worker would be automatically enrolled in a 401(k)-type plan. It is cheap, simple and would practically eliminate poverty in old age.

There’s substantial evidence, from the U.S. and other countries, that middle- and high-income households reduce their retirement saving in response to government pension benefits. Gradually lowering their benefits would prompt them to boost their saving.

To help workers save more, Congress should make it cheaper and easier for small businesses to offer 401(k)s. Plus, federal law should require all employers offering 401(k)s to automatically enroll employees, who can always opt out.

MS. MUNNELL: Policy makers should encourage nearly everyone to save more and those who can work longer to do so.

Individuals should be made aware that 70 is the age at which they receive maximum Social Security benefits, and that retiring earlier significantly reduces monthly benefits.

Since most people only save successfully through organized savings mechanisms, we should:   ............

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