The 70 percent income replacement rate, which for decades has been the rule of thumb in assessing the country’s state of retirement readiness, is too arbitrary and ultimately “of little use” in measuring economic preparation for retirees, according to two researchers from the RAND Corp.

For some savers, a 70 percent replace rate proves woefully inadequate.

For others, it is too aggressive, writes Michael Hurd and Susann Rohwedder, in Measuring Income Preparation for Retirement: Income vs. Consumption, published through the University of Michigan’s Retirement Research Center.

The researchers’ bottom line: new ways of benchmarking income replacement rates are needed, as core variables to the modern retirement landscape now affect simulation models in ways they previously hadn’t.

The migration from defined benefit plans and to defined contribution plans is one reason why traditional replacement-rate thinking has become anachronistic, say the researchers.

Drawdown rates on 401(k) and IRA accounts may vary, and savings in those plans are affected by market volatility in ways pensions are not.

Also, in a married household, both spouses may work, and may not retire in lockstep.

Meantime, the definition of retirement has changed: for many, it now incorporates part-time and even fulltime employment, they note.

On balance, retirement income is more dependent on less predictable resources.

To account for these changes, the paper test three variations on income replacement rates, to address the “complexities of the contemporary labor and investment markets available to workers near retirement age.”

The first replacement rate accounts for social security and pension income, the second adds income from drawdowns on 401(k) and IRA assets, and the third adds on potential income from annuities.

The research also attempts to compare the retirement readiness rates of single persons with married couples, by estimating the adequacy of a 70 percent income replacement rate with the different consumption habits of single retirees and couples.

Make sense yet?

When not considering a consumption-based model of retirement readiness, singles tend to be better of than couples: when accounting for the most compressive estimate of sources of income, 54 percent of singles were able to replace 70 percent of income, compared to just 41 percent of married persons.

But the paper notes that comparison is deceptive, as single people made considerable lower income, and were therefore able to replace more of it.

When using a consumption-based modeling, married couples end up faring much better, largely because they benefit from economies of scale in retirement—cheaper to buy for two people with two sources of retirement income.

Accounting for consumption habits provides for the best metric, the researchers say. Under that model, 81 percent of married persons in the sampling were able to replace at least 70 percent of income in retirement, compared to 59 percent of singles.

Though not listed in its conclusions, the paper could be a tacit endorsement for retirement advisors, and their ability to set goals relative to individuals’ varied financial portfolios and spending needs.

These days, too many variables exist to make one rule of thumb replacement standard acceptable to all, the paper seems to conclude.

The researchers also acknowledge that industry is moving away from applying one standard across the board.

“While income replacement rates have been used widely until recently in online financial planning tools, several companies have moved away from this concept,” says the paper.

“Instead they suggest households first try to predict their lifestyle in retirement, acknowledging that this may vary a lot across households,” it adds.

Instant Insights /

Income replacement rate needs vary widely: RAND experts

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