Issue Brief
No. 297
September 2006
Measuring Retirement Income Adequacy:
Calculating Realistic Income Replacement Rates
By Jack VanDerhei, Temple University and EBRI Fellow
•
•
•
•
•
•
•
The limitations of traditional “replacement rate” calculations: For decades, “replacement rates” have been the
primary “rule-of-thumb” measure used in the retirement planning process. However, replacement rate calculations
are overly simplistic and potentially inaccurate because they often are based on methodologies limited to
replacement of preretirement cash flow after adjustment for taxes, savings, and age and/or work-related expenses.
Importance of investment, longevity and health risks: One of the biggest weaknesses of replacement rate models
is that one or more of the most important retirement risks is ignored: investment risk, longevity risk, and risk of
potentially catastrophic health care costs.
A new “building block” approach: This Issue Brief illustrates the problematic nature of using conventional
replacement rates for retirement planning through a “building block” approach: Building Block 1 focuses
exclusively on investment risk; Building Block 2 introduces longevity risk into the planning process, in addition to
the investment risk from the previous level; Building Block 3 introduces the risk of catastrophic health care costs
into the calculations, in addition to investment and longevity risk.
A more realistic way to calculate replacement rates: Building Block 3 represents the approach that will be used in
a new Web-based planning tool to assist preretirees in their attempt to choose a meaningful replacement rate for
purposes of retirement planning. This resource will be released in 2007 as a free online tool called the Ballpark
E$stimate® Monte Carlo.
The importance of probabilities: Some retirement planning models that, by default, use average values for
longevity, investment, and health costs implicitly are using a 50 percent probability of success. Since most
preretirees will want a higher probability of success, the Ballpark E$stimate® Monte Carlo model also shows results
for 75 and 90 percent probability of success.
Individualized results: In reality, there is no “correct” single replacement rate. Even at a specified probability of
success, an “adequate” replacement rate depends dramatically on the level of retirement expenditures, retirement
age, gender, asset allocation, percentage of annuitization, and other variables detailed in this Issue Brief.
Conversion of the savings needed to a multiple of final earnings that is needed in retirement savings can provide
a clearer picture for some, so the Issue Brief presents that as well (see pages 11, 16, and 29).
Examples: Variation in target replacement rates can be seen below (for the case in which there is no equity
allocation of assets and none of the initial retirement wealth is annuitized):
Target Replacement Rates for High-Income Individuals (single retirees making more than $40,450 per year; 4.6 percent)
Probability of
Retirement “Adequacy”
50%
75
90
Male retiring at 65
52%
78
119
Female retiring at 65
59%
98
128
Male retiring at 62
64%
97
149
Male retiring at 68
43%
66
97
Target Replacement Rates for Low-Income Individuals (single retirees making less than $15,000 per year; 70.3 percent)
Probability of
Retirement “Adequacy”
50%
75
90
•
Male retiring at 65
124%
229
394
Female retiring at 65
147%
292
453
Male retiring at 62
153%
285
476
Male retiring at 68
95%
206
332
While these replacement rates will be larger than those typically contemplated for some individuals, this Issue Brief
explores how the purchase of annuities at the time of retirement may be used as an effective risk management
technique in some cases to reduce these targets.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
Jack VanDerhei, Temple University, is research director of the EBRI Fellows Program. Special thanks to
Craig Copeland, senior research associate at EBRI, for his assistance with this report. Several of the
assumptions used in this report are based on findings published by Paul Fronstin, senior research associate
and director of the health research and education program at EBRI, in “Savings Needed to Fund Health
Insurance and Health Care Expenses in Retirement,” EBRI Issue Brief no. 295, July 2005.
Note: The electronic version of this publication was created using version 6.0 of Adobe® Acrobat.® Those having
trouble opening the pdf document will need to upgrade their computer to Adobe® Reader® 6.0, which can be
downloaded for free at www.adobe.com/products/acrobat/readstep2.html
Table of Contents
Introduction.......................................................................................................................................4
Recent EBRI Research......................................................................................................................5
Methodology.....................................................................................................................................6
Results...............................................................................................................................................8
Building Block 1: Investment Risk Only.................................................................................................... 8
Building Block 2: Investment and Longevity Risk..................................................................................... 9
Building Block 3: Investment, Longevity and Long-Term Care Risk ...................................................... 12
Conclusion ......................................................................................................................................18
References.......................................................................................................................................19
Endnotes .........................................................................................................................................20
Figures
Figure 1, Impact of Initial Retirement Wealth on the Probability of Retirement Income "Adequacy,"
by Equity Allocation. For: Males Retiring at Age 65 in the Lowest Income Category.................... 8
Figure 2, Impact of Initial Retirement Wealth on the Probability of Retirement Income "Adequacy,"
by Equity Allocation. For: Males Retiring at Age 65, Retirement Income Category 2.................... 10
Figure 3, Impact of Initial Retirement Wealth on the Probability of Retirement Income "Adequacy,"
by Equity Allocation. For: Males Retiring at Age 65, Retirement Income Category 3.................... 10
Figure 4, Impact of Initial Retirement Wealth on the Probability of Retirement Income "Adequacy,"
by Equity Allocation. For: Males Retiring at Age 65 in the Highest Income Category................... 11
Figure 5 Impact of Final Earnings Multiple on the Probability of Retirement Income "Adequacy,"
by Retirement Income Category (Assumes 100% Equity Allocation). For: Males Retiring
at Age 65........................................................................................................................................... 11
Figure 6, Replacement Ratios Required for Various Probability Levels of "Adequacy," by Income
Category and Equity Allocation. For: Males Retiring at Age 65 ..................................................... 13
Figure 7, Necessary Replacement Rates for Retirement Income "Adequacy," by Retirement Income
Category and Equity Allocation (Various Probabilities). For: Males Retiring at Age 65 ................ 13
Figure 8, Impact of Replacement Rates on the Probability of Retirement Income "Adequacy," by
Retirement Income Category and Equity Allocation........................................................................ 14
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
2
Figure 9, Impact of Initial Retirement Wealth on the Probability of Retirement Income "Adequacy,"
by Equity Allocation. For: Males Retiring at Age 65 in the Lowest Income Category ................... 14
Figure 10, Impact of Initial Retirement Wealth on the Probability of Retirement Income "Adequacy,"
by Equity Allocation. For: Males Retiring at Age 65 in the Highest Income Category................... 16
Figure 11, Impact of Final Earnings Multiple on the Probability of Retirement Income "Adequacy,"
by Retirement Income Category (Assumes 100% Equity Allocation and No Annuitization).
For: Males Retiring at Age 65 .......................................................................................................... 16
Figure 12, Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income
Category, Equity Allocation, and Rate of Annuitization. For: Males Retiring at Age..................... 17
Figure 13, Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Rate of
Annuitization (Assumes Lowest Income Category and No Equity Investment).............................. 18
Figure 14, Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income
Category, Equity Allocation, and Rate of Annuitization. For: Males Retiring at Age 65................ 22
Figure 15, Impact of Defined Contribution Balance on Probability of "Adequate" Retirement Income,
by Annuitization (Assumes 0% Equity Allocation). For: Males Retiring at Age 65 in the Lowest
Income Category .............................................................................................................................. 23
Figure 16, Impact of Defined Contribution Balance on Probability of "Adequate" Retirement Income,
by Annuitization (Assumes 50% Equity Allocation). For: Males Retiring at Age 65 in the Lowest
Income Category .............................................................................................................................. 23
Figure 17, Impact of Defined Contribution Balance on Probability of "Adequate" Retirement Income,
by Annuitization (Assumes 0% Equity Allocation). For: Males Retiring at Age 65 in the Highest
Income Category .............................................................................................................................. 24
Figure 18, Impact of Defined Contribution Balance on Probability of "Adequate" Retirement Income,
by Annuitization (Assumes 50% Equity Allocation). For: Males Retiring at Age 65 in the Highest
Income Category .............................................................................................................................. 24
Figure 19, Replacement Ratios Required for a 50% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Lowest Income Category ........................................................................................... 25
Figure 20, Replacement Ratios Required for a 75% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Lowest Income Category ........................................................................................... 25
Figure 21, Replacement Ratios Required for a 90% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Lowest Income Category ........................................................................................... 26
Figure 22, Replacement Ratios Required for a 50% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Highest Income Category .......................................................................................... 26
Figure 23, Replacement Ratios Required for a 75% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Highest Income Category .......................................................................................... 27
Figure 24, Replacement Ratios Required for a 90% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Highest Income Category .......................................................................................... 27
Figure 25, Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income
Category, Equity Allocation, and Rate of Annuitization. For: Males Retiring at Age 65................ 28
Figure 26, Impact of Final Earnings Multiple on the Probability of Retirement Income "Adequacy,"
by Retirement Income Category (Assumes 100% Equity Allocation and No Annuitization).
For: Males Retiring at Age 65 .......................................................................................................... 29
Figure 27, Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income
Category, Equity Allocation, and Rate of Annuitization. For: Females Retiring at Age 65 ............ 30
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
3
Figure 28, Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income
Category, Equity Allocation and Rate of Annuitization. For: Males Retiring at Age 62................. 31
Figure 29, Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income
Category, Equity Allocation, and Rate of Annuitization. For: Males Retiring at Age 68................ 32
Figure 30, Replacement Ratios Required for a 50% Chance of "Adequacy." For: Males Retiring at
Age 65, Lowest Income Category .................................................................................................... 33
Figure 31, Replacement Ratios Required for a 75% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Lowest Income Category ........................................................................................... 33
Figure 32, Replacement Ratios Required for a 90% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Lowest Income Category ........................................................................................... 34
Figure 33, Replacement Ratios Required for a 50% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Highest Income Category........................................................................................... 34
Figure 34, Replacement Ratios Required for a 75% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Highest Income Category........................................................................................... 35
Figure 35, Replacement Ratios Required for a 90% Chance of "Adequacy." For: Males Retiring at
Age 65 in the Highest Income Category........................................................................................... 35
Introduction
For decades, “replacement rates” have been the primary measure used in the retirement planning process.
This is defined as the annual amount of an individual’s retirement income, divided by his or her yearly
earnings just prior to retiring. For instance, someone who retires from a job with a $100,000 annual salary
and has $75,000 a year in retirement income has a “replacement rate” of 75 percent.
A “Part 1” article by EBRI (VanDerhei, EBRI Notes, September 2004) reviewed how these rates have
traditionally been used to establish minimum targets for future retirees by calculating the amount needed to
provide the same amount of after-tax income in retirement as that received prior to retirement after adjusting
for differences in savings, age, and work-related expenses. Results from one of the most commonly cited
studies indicated that for a one wage-earner family retiring at 65 with a spouse age 62, the target replacement
rates were between 75–89 percent (depending on income) in 2004 (Alford, Farnen, and Schachet, 2004).
Previous research on projected replacement rates found that typical 401(k) participants at very large
employers were well positioned to replace 85–95 percent of preretirement income when current Social
Security and existing profit-sharing and defined benefit plans are taken into account (Steinberg and Lucas,
2004). However, the likely adequacy of these income replacement rates is a function of what type of postretirement health care coverage a worker has from a previous employer.
Steinberg and Lucas subtracted retiree medical costs net of subsidies from retirement income levels to
determine a “net” replacement income ratio, reflecting the percentage of preretirement income available to
meet all needs other than medical. As a result, the overall average replacement ratio for their analysis drops
from 95 percent under the high medical coverage assumption to 83 percent under the medium assumption
and 80 percent under the low medical coverage assumption. This is true for employees retiring at a “normal”
retirement age of 65, and who are relying primarily on Medicare for their health care benefits. Employees
retiring at an earlier age will experience even larger financial modifications. While these techniques provide
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
4
simple rule-of-thumb measures for the retirement planning process,1 there have been recent attempts to
conceptually redefine retirement income adequacy (Schieber, 1996 and 1998). Moreover, it is important to
understand that the current methodologies (however modified) only solve for the amount of money needed to
provide the same annual cash flow available prior to retirement (albeit adjusted for taxes, savings, age and/or
work-related expenses and, in some cases, the cost of post-retirement health care), and ignore some or all of
the risks of longevity, investment of retirement assets, and catastrophic health care costs (such as a prolonged
stay in a nursing home without the benefit of long-term care insurance).
Recent EBRI Research
EBRI has recently completed a simulation model—the EBRI/ERF Retirement Security Projection
Model® (RSPM)—that incorporates a wide range of data in order to produce a far more inclusive and refined
projection of likely retirement income. The model projects defined benefit accruals, defined contribution,
cash balance, and individual retirement account (IRA) balances, Social Security income, and net housing
equity for Americans born between 1936 and 1965, inclusive (VanDerhei and Copeland, 2003). At
retirement age, the model simulates 1,000 alternative life paths for each family unit to assess whether the
retirement accumulations will be sufficient to pay both basic (deterministic) and health-related (stochastic)
expenditures for the simulated life-path, or whether additional outside savings would be required to prevent
deficits in retirement.
The purpose of this Issue Brief is to show the results obtained by utilizing the concepts already adopted
by RSPM for the entire population of certain age cohorts and apply them to stylized examples. These results
will provide useful information for individuals attempting to include such crucial factors as longevity,
investment, and health care risk into their retirement planning process. In 2007, EBRI plans to roll out
Ballpark E$timate® Monte Carlo2⎯ a companion Web site to its current Ballpark E$stimate® retirement
planning worksheet⎯that will allow preretirees to determine the appropriate replacement rate target before
attempting to determine their desired savings rates.
After a brief review of the methodology, this Issue Brief takes the results of the new model and simulates
what replacement rates are required to provide “adequate” retirement income 50 percent, 75 percent, and
90 percent of the time.3 Depending on which of the risk elements are introduced into the planning process
and what statistical confidence is desired, the new replacement rate targets will be seen to be larger (in some
cases considerably so) than the previous benchmarks.
Moreover, the huge variation in the range of replacement rate targets—depending on the individual's
income, degree of annuitization for initial retirement wealth, and the asset allocation of the post-retirement
investments—call into question whether the use of a single rule-of-thumb measure is realistic to use in the
retirement planning process. Given the huge variation of individual circumstances (such as age, health, and
income) and the complexity of retirement risks that need to be dealt with—such as longevity (addressed
through annuitization of assets), old-age infirmity (addressed through long-term care insurance), and asset
preservation (addressed through investment allocation)—a simple one-size-fits-all replacement rate will not
work for most Americans.
The results of this model reveal, in many cases, the sobering (if not staggering) amounts of money
needed to provide a reasonable high chance of being able to afford retirement. However, they also show the
positive results that can be obtained by annuitizing assets in retirement to protect against the risk of
longevity. In this regard, the model points not only to a more realistic size of the retirement income problem
but also ways that individuals can begin to deal with it.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
5
Methodology
Although the Web-based version of the Ballpark E$timate® Monte Carlo will allow individuals4 to input
their specific information, for purposes of illustrating its capacities in this Issue Brief, we start with stylized
situations whereby each of the following variables are specified:5
• Gender.
• Retirement age.
• Equity allocation after retirement.
• Percentage of initial retirement wealth to be annuitized at retirement.6
• Preretirement income.
• Initial Social Security benefit.
• Defined benefit amount (if any).7
At this point the model user is given a choice of:
1. Specifying the amount of initial retirement wealth available8 and having the program simulate a
probability of having "adequate" retirement income (defined below); or
2. Specifying the probability of having "adequate" retirement income and having the program simulate
the amount of initial retirement wealth needed.
In either case, the initial retirement wealth can be specified as (a) a dollar amount, (b) a multiple of final
earnings, or (c) a replacement ratio.
Once the initial values are chosen, the program runs a large number of simulated life paths9 that include
the following calculations on an annual basis for either the specified level of initial retirement wealth in the
first option above, or an entire vector of initial retirement wealth balances in the second option:
1. Simulate the annual expenditures and the annual rate of return.
2. Calculate the Social Security benefit, the annuitized portion of the initial retirement wealth (if any)
and the amount paid from the defined benefit plan (if any) for the year.
3. If the sum of the simulated investment income and amounts paid from Social Security, the annuitized
portion of the initial retirement wealth (if any) and the defined benefit plan (if any) exceed the
simulated expenditures for the year, any excess amounts are invested. If the sum of the simulated
investment income and amounts paid from Social Security, the annuitized portion of the initial
retirement wealth (if any) and the defined benefit plan (if any) is less than the simulated expenditures
for the year, any difference is removed from the accumulated retirement wealth.
4. If the accumulated retirement wealth is simulated to turn negative, it is assumed that loans are taken
out to continue consumption at the specified levels.10
At the end of the simulated life path,11 the program determines whether there is a non-negative amount
left in the retirement wealth balance. If so, there is “adequate” retirement income for this life path. After the
entire range of simulated life paths have been run for each level of initial retirement wealth, a probability of
“adequate” retirement income is computed. This value is defined as the percentage of simulated life paths
with “adequate” retirement income.
Replacement rates are computed by taking each of the initial retirement wealth levels and assuming they
have been annuitized at retirement age at current annuity purchase prices. The initial value of the assumed
initial Social Security annual benefit (before any COLAs) is added to this value.12 The sum of these values is
divided by the assumed terminal earnings to produce the replacement rates. Linear interpolation is used to
estimate the replacement ratio required to produce “adequate” retirement income for three different levels:
1. 50 percent of the time (this has about the same result as using averages for life expectancy,
investment experience, and health care costs, as often done in some applications).
2. 75 percent of the time.
3. 90 percent of the time.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
6
Although users of the Web version of the model will be allowed to input their own assumptions with
respect to investment income, for purposes of illustration, this Issue Brief assumes just two asset classes: (1)
a diversified equity portfolio with a stochastic return with a real mean of 6.5 percent and a 100 basis point
investment expense, and (2) a non-equity option that is chosen to be deterministic with a net real rate of
return equal to 2.5 percent.13
The model allows users to specify their inflation assumptions for several components, but this Issue Brief
assumes that general inflation will be 2.8 percent per annum and that inflation for health care components
(unless otherwise denoted) will be 7 percent.
Retirement expenditure data may be input by the users but guidance will be provided based on four
stylized examples with different combinations of preretirement income, Social Security benefits, and
retirement expenditures. For purposes of the Issue Brief, retirement expenditures are based on total
expenditures net of health care (which is calculated separately) for the following four retirement income
categories:
1.
2.
3.
4.
Those making less than $15,000 a year (70.3 percent of single retirees based on the 2000
Consumer Expenditure Study14).
Those making at least $15,000 but less than $30,000 (20.6 percent of single retirees).
Those making at least $30,000 but less than $40,450 (4.5 percent of single retirees).
Those making more than $40,450 (4.6 percent of single retirees).
The 2006 values for retirement expenditures net of health care vary from $15,969 for the lowest income
category to $38,097 for the highest income category. 15
Initial Social Security benefits and terminal wages may be input by the users,16 but for purposes of the
Issue Brief these amounts were calculated for the four income categories above from 2004 Current
Population Survey (CPS) data and brought forth to 2006 by increasing the amounts by 6.9 percent. Early and
late retirement assumes terminal wages are adjusted by 3.9 percent per year and that the appropriate actuarial
modifications were made to Social Security benefits.
Nursing home assumptions are coded into the model with separate simulations for the probability and
severity of each event. The probability of being admitted to a nursing home is simulated each year as a
function of age and previous health care needs category based on results from the 1999 National Nursing
Home Survey (NNHS). The length of stay is simulated based on the duration of stays at nursing homes found
in the NNHS. The monthly cost was based on a figure of $3,947 and adjusted to 2006 for inflation.17 Home
health care assumptions were simulated in a similar fashion, with the monthly cost based on a figure of
$1,280 and adjusted to 2006 for inflation.18
Other health care assumptions are bifurcated based on Medicare eligibility. If the individual is Medicareeligible for any portion of the simulated life path, then the other health care expenditures in that year are
equal to the sum of the premiums for Medigap and Medicare Part B plus the simulated drug cost. The annual
Medigap premium was assumed to be $1,755 adjusted for future inflation at 7 percent, and the Medicare part
B premium was assumed to be $1,062 adjusted for future inflation at 3.9 percent (Fronstin, 2006). The
simulated drug cost was based on age-specific quartiles of drug expenses adjusted for Medicare Part D
premiums and benefits and adjusted for inflation at 8.6 percent per year (Fronstin, 2006). For ages in the
simulated life path when the individual is not Medicare eligible, other health care expenditures are equal to
an HMO (health maintenance organization) cost that is age-specific and adjusted for inflation at the general
healthcare inflation rate.19
Taxes are based on federal income taxes for a single taxpayer using 2005 tax rates. The amount of Social
Security benefits included in taxable income as a result of the 1983 amendments are coded into the program
which will result in increased amounts of retirement income needed for future cohorts to pay for the same
after tax amount of consumption in retirement. For purposes of this Issue Brief, it is assumed that all
retirements take place in the year 2006.20
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
7
Results
This section illustrates the problematic nature of using conventional replacement rates for retirement
planning through a “building block” approach:
Building Block 1 focuses exclusively on investment risk. As retirees increase their equity allocation, they
could potentially benefit from a higher expected investment income; however, they will also face more
volatility in annual results and a larger potential downside. The calculations presented in this approach use
average longevity as well as average long-term care costs for the retirees.
Building Block 2 introduces longevity risk into the planning process, in addition to the investment risk
from the previous level. In addition to providing the retiree with decisions with respect to investments, this
also provides the opportunity to mitigate overall risk through the purchase of immediate annuities at
retirement age (as noted earlier, actual annuity purchase prices are utilized in the calculations). The
calculations presented in this approach use average long-term care costs for the retirees.
Building Block 3 introduces the risk of health care costs into the calculations. This provides the
framework necessary to evaluate the potential benefits of long-term care insurance as a way of increasing
overall probability of retirement adequacy.21
Building Block 1: Investment Risk Only
Figure 1 shows the results of the simulations for a male in the lowest income category retiring at age 65
and living to exactly age 82. If this retiree were to retire with an account balance of $300,000 and chose an
asset allocation that included no equities, he would have virtually no chance of having “adequate” retirement
income. If the equity allocation were increased to 25 percent, the probability of success increases
substantially to 43 percent. Additional increases in the equity allocation result in larger probabilities of
adequate retirement income: 50 percent equities yields a 52 percent probability of success, 75 percent
equities translates to a 56 percent probability of success, and an all-equity portfolio would provide
“adequate” retirement income in 58 percent of the simulated runs.
Figures 2 through 4 provide similar results for males retiring at age 65 in income categories 2 though 4 (lower
to highest), respectively. Given that expenditures are assumed to increase with income, each successive income
Figure 1
Impact of Initial Retirement Wealth on the Probability of
Retirement Income "Adequacy," by Equity Allocation
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 1 (investment income stochastic, longevity and health care expenses
Probability of Adequacy
100%
90%
80%
Equity Allocation
70%
60%
50%
40%
30%
20%
0%
25%
50%
75%
100%
10%
$1 $
00 0
$2 ,00
00 0
$3 ,000
00
$4 ,00
00 0
$5 ,000
00
$6 ,00
00 0
$7 ,000
00
$8 ,00
00 0
$9 ,000
0
$1 0,0
, 0 00
0
$1 0,0
, 1 00
0
$1 0,0
, 2 00
0
$1 0,0
, 3 00
0
$1 0,0
, 4 00
0
$1 0,0
, 5 00
0
$1 0,0
, 6 00
0
$1 0,0
, 7 00
0
$1 0,0
, 8 00
0
$1 0,0
, 9 00
0
$2 0,0
, 0 00
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Inst it ute, Ballpark E$timate® M onte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
8
category will require a larger initial retirement wealth for the same probability of success. Conversely, the
probability of adequate retirement income will decrease for a given initial retirement wealth and equity
allocation as the income category increases. The following table demonstrates this:
Probability of Adequate Retirement Income for Building Block 1
for a Male Retiring at Age 65 With an Account Balance of $300,000
Equity Allocation
Retirement Income Category
0%
25%
50%
75%
100%
1 (Lowest)
0%
43%
52%
56%
58%
2
0
29
47
51
51
3
0
18
39
48
47
4 (Highest)
0
0
4
17
23
The higher expected return but larger volatility of equity returns is demonstrated in these graphs. In each
case, a 50 percent probability of adequate retirement income can be provided for a smaller initial retirement
wealth when the assets are invested 100 percent in equities. However, the increased volatility of equities
causes these lines to cross, and if a retiree desired a 90 percent chance of adequate retirement income, the
100 percent equity allocation would require the largest initial retirement wealth.
Some financial planners will attempt to simplify the threshold needed for adequate retirement income by
converting the initial retirement wealth to a multiple of final earnings. Figure 5 demonstrates the results of
restating the previous figures into this metric for the highest and lowest income categories for 100 percent
equity allocations. If the retiree were in the highest income group and desired a 75 percent chance of
adequate retirement income, he would require an initial retirement wealth of 4.2 times final earnings if he
were to invest 100 percent in equities. However, if the same equity allocation were chosen by a low-income
retiree, he would require an initial retirement wealth of 12.1 times final earnings.
Figure 6 demonstrates the probability of retirement adequacy expected for each replacement rate for the
highest and lowest income categories for both zero and 100 percent equity allocations (Figure 7).22 If a highincome retiree were simply interested in a 50 percent probability of adequacy, he would require a 48 percent
replacement rate if he invested 100 percent in equities and a 58 percent replacement if no assets were
invested in equities. The same figures jump to 117 percent (all equity) and 146 percent (no equity) for the
low-income retiree. If, instead, a male retiring at age 65 desired a 90 percent probability of adequate
retirement income, the necessary replacement rate would be 66 percent for a high-income retiree with no
investment in equities and 87 percent with 100 percent investment in equities. His low-income counterpart
would require a 185 percent replacement rate with no equity investments and a 232 percent replacement rate
with 100 percent investment in equities.
Figure 8 illustrates the probable levels of adequacy and equity allocations with respect to the required
replacement ratios.
Building Block 2: Investment and Longevity Risk
This approach relaxes the assumption that the retiree will live to the average life expectancy (the point at
which 50 percent of those reaching the retirement age are still alive and 50 percent have passed⎯currently
82 for men and 85 for women at age 65) and introduces longevity risk. Figure 9 provides the same analysis
for a low-income retiree as was presented in Figure 1, although when longevity risk is introduced there will
be opportunities for those with low initial retirement wealth to have a non-zero probability of adequacy
(meaning those who are simulated to die within a few years of retirement before they have exhausted their
initial retirement wealth). However, the additional longevity risk requires larger initial retirement wealth for
those seeking a 90 percent probability of retirement adequacy. In Figure 1, a zero equity allocation would
require approximately $500,000 in initial retirement wealth, whereas in Figure 9, the same probability would
need approximately a $600,000 balance. Figure 10 shows similar results for a high-income retiree.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
9
Figure 2
Impact of Initial Retirement Wealth on the Probability of
Retirement Income "Adequacy," by Equity Allocation
For: Males Retiring at Age 65, Retirement Income Category 2
Option: Building Block 1 (investment income stochastic, longevity and health care expenses deterministic)
100%
90%
80%
Probability of Adequacy
Equity Allocation
70%
0%
60%
25%
50%
50%
75%
40%
100%
30%
20%
10%
$0
$1
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 3
Impact of Initial Retirement Wealth on the Probability of
Retirement Income "Adequacy," by Equity Allocation
For: Males Retiring at Age 65, Retirement Income Category 3
Option: Building Block 1 (investment income stochastic, longevity and health care expenses deterministic)
100%
90%
80%
Probability of Adequacy
Equity Allocation
70%
0%
60%
50%
40%
25%
50%
75%
100%
30%
20%
10%
$0
$1
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
10
Figure 4
Impact of Initial Retirement Wealth on the Probability of
Retirement Income "Adequacy," by Equity Allocation
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 1 (investment income stochastic, longevity and health care expenses deterministic)
100%
90%
80%
Probability of Adequacy
Equity Allocation
70%
0%
60%
25%
50%
50%
75%
40%
100%
30%
20%
10%
$0
$1
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 5
Impact of Final Earnings Multiple on the Probability of
Retirement Income "Adequacy," by Retirement Income Category
(Assumes 100% Equity Allocation)
For: Males Retiring at Age 65
Option: Building Block 1 (investment income stochastic, longevity and health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
70%
Low Income
60%
High Income
50%
40%
30%
20%
10%
0%
-
5
10
15
20
25
30
35
40
Final Earnings Multiple
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
11
Figure 11 provides similar analysis in terms of final earnings multiples and Figure 12 demonstrates the
impact of replacement rates on the probability of adequate retirement income by income category, equity
allocation and rate of annuitization.
Figures 13 and 14 demonstrate the value of purchasing an immediate annuity at retirement age for those
interested in a high probability of retirement income adequacy. Assuming a low-income male retiring at age
65 with no equity investments desires a 90 percent chance of retirement income adequacy, the necessary
replacement rate without an annuity would be approximately 241 percent. If 25 percent of the initial
retirement wealth were annuitized immediately, the replacement rate could be reduced to approximately
213 percent. Additional increases in the percentage of account balances annuitized result in further drops in
the necessary replacement rate: 50 percent annuitization would require a replacement rate of 188 percent,
75 percent annuitization would require approximately 177 percent and 100 percent annuitization would
require approximately 166 percent.
Although Figure 13 was a convenient educational device to illustrate how annuitization may help those
desiring higher probabilities of adequate retirement income to achieve it with lower replacement rates, it is
important to note that in reality the optimal degree of annuitization will vary by income category as well as
asset allocation.23 Figures 15 and 16 demonstrate how the optimal degree of annuitization varies by asset
allocation for a low-income individual. In Figure 15, a retiree with no equity allocation would be better off
annuitizing if he or she desired more than a 40 percent chance of adequate retirement income; however, in
Figure 16, a retiree investing 50 percent of the initial retirement wealth in equities would need at least a
55 percent chance of adequate retirement income as a target before annuitization would be useful. Figures 17
and 18 show similar results for high-income retirees.
The tradeoffs between equity allocation and degree of annuitization are shown directly for various
probabilities of adequacy in Figures 19, 20, and 21 for those in the lowest income category. Similar analyses
are provided for the highest income category in Figures 22, 23, and 24.
Building Block 3: Investment, Longevity, and Long-Term Care Risk
For purposes of retirement planning, it is typically assumed that most, if not all, of the retiree expenses
will behave in a predictable fashion. For example, in this model, it is assumed that knowing one's retirement
income, age, and real estate status, one can make reasonable predictions regarding many of the expenditures
in retirement. However, one major exception to this deals with long-term care costs. This section adds in the
third of these “building blocks” to try to deal with a situation that could prove financially catastrophic to a
retirement plan that otherwise has dealt adequately with investment and longevity risk. Although this Issue
Brief does not attempt to provide private market alternatives to dealing with this risk, as it did with longevity
risk in the previous section, plans are under way to include such options in the Web-based version of this
model.
Figure 25 demonstrates the relationship between replacement rates and probability of retirement
adequacy by equity allocation and annuitization for each of the four income categories for a male retiring at
age 65. Figure 26 shows a similar relationship in terms of final earnings multiples for the highest and lowest
income category. The following provides a simple example of the impact of adding long-term care as a
stochastic variable for a retiree in the highest income category, assuming no equity allocation and none of the
initial retirement wealth is annuitized:
Replacement Rate Needed Under:
Probability of Adequate
Retirement Income
50%
75%
90%
Building Block 2
50%
68
87
Building Block 3
52%
78
119
Difference Between
the Two:
2%
10
32
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
12
Figure 6
Replacement Ratios Required for Various Probability Levels
of "Adequacy," by Income Category and Equity Allocation
For: Males Retiring at Age 65
Option: Building Block 1 (investment income stochastic, longevity and health care expenses deterministic)
250%
Equity Level
Lowest Income, 0% Equity
Lowest Income, 100% Equity
200%
Highest Income, 0% Equity
Replacement Rate
Highest Iincome, 100% Equity
150%
100%
50%
0%
50%
75%
90%
Probablity of Retirement Income "Adequacy"
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 7
Necessary Replacement Rates for Retirement Income "Adequacy," by
Retirement Income Category and Equity Allocation (Various Probabilities)
For: Males Retiring at Age 65
Option: Building Block 1 (investment income stochastic, longevity and health care expenses deterministic)
Equity Allocation3
Probability of Retirement
1
Income "Adequacy"
50%
75%
90%
50%
75%
90%
50%
75%
90%
50%
75%
90%
Retirement
2
Income Category
1
2
3
4
0%
146%
156
185
75
80
96
61
65
80
57
59
66
25%
131%
150
175
71
78
90
61
66
75
53
58
64
50%
124%
148
178
67
78
93
58
67
77
51
58
69
75%
120%
153
204
66
82
103
55
69
84
48
61
73
100%
117%
166
232
65
88
119
56
73
103
48
63
87
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 20, 2006 version.
See text for definition of retirement income adequacy (90% is most likely to have adequate income in retirement).
2
See text for definition of retirement income category (1 is lowest, 4 is highest).
3
Percentage of retirement assets invested in stocks (equities).
1
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
13
Figure 8
Impact of Replacement Rates on the Probability of Retirement Income
"Adequacy," by Retirement Income Category and Equity Allocation
For: Males Retiring at Age 65
Option: Building Block 1 (investment income stochastic, longevity and health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
70%
Lowest Income, No Equity
60%
Lowest Income, All Equity
50%
Highest Income, All Equity
40%
Highest Income, No Equitiy
30%
20%
10%
0%
0%
100%
200%
300%
400%
500%
600%
700%
Replacement Rate
®
Source: Employee Benefit Research Institute, Ballpark E$timate Monte Carlo, August 2006 version.
Figure 9
Impact of Initial Retirement Wealth on the Probability of
Retirement Income "Adequacy," by Equity Allocation
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
70%
Equity Allocation
60%
50%
0%
25%
50%
40%
30%
75%
100%
20%
10%
$0
$1
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
14
Similar analyses are presented for females retiring at age 65 in Figure 27. The following is a simple
summary of the impact of the gender differentials. In each case, it is assumed there is no equity allocation
and none of the initial retirement wealth is annuitized:
Lowest-Income Category
Replacement Rate Needed for:
Probability of Adequate
Retirement Income
Male
Female
50%
124%
147%
75%
229
292
90%
394
453
Highest-Income Category
Replacement Rate Needed for:
Probability of Adequate
Retirement Income
Male
Female
50%
52%
59%
75%
78
98
90%
119
128
The impact of early retirement on replacement rates is explored in Figure 28. In this case, a male is
assumed to retire at age 62, take a permanently subsidized early retirement benefit from Social Security, and
pay the cost of health coverage himself until he is eligible for Medicare at age 65. Figure 29 shows the
impact of late retirement by analyzing the relationship between replacement rates and probability of adequate
retirement income for a male retiring at age 68. In this case, we assume that initial receipt of Social Security
benefits is delayed until retirement age.
The following is a simple summary of the impact of various retirement ages for males. In each case we
assume there is no equity allocation and none of the initial retirement wealth is annuitized:
Highest-Income Category
Replacement Rate Needed Under:
Probability of Adequate
Retirement Income
50%
75%
90%
Male, 65
52%
78
119
Male, 62
64%
97
149
Male, 68
43%
66
97
Lowest-Income Category
Replacement Rate Needed Under:
Probability of Adequate
Retirement Income
50%
75%
90%
Male, 65
124%
229
394
Male, 62
153%
285
476
Male, 68
95%
206
332
The tradeoffs between equity allocation and degree of annuitization are shown directly for various
probabilities of adequacy in Figures 30, 31, and 32 for those in the lowest income category. Similar analyses
are provided for the highest income category in Figures 33, 34, and 35.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
15
Figure 10
Impact of Initial Retirement Wealth on the Probability of
Retirement Income "Adequacy," by Equity Allocation
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
70%
60%
Equity Allocation
50%
0%
25%
40%
50%
30%
75%
100%
20%
10%
$$1
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
®
Source: Employee Benefit Research Institute, Ballpark E$timate Monte Carlo, August 2006 version.
Figure 11
Impact of Final Earnings Multiple on the Probability of
Retirement Income "Adequacy," by Retirement Income Category
(Assumes 100% Equity Allocation and No Annuitization)
For: Males Retiring at Age 65
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
70%
Low Income
60%
High Income
50%
40%
30%
20%
10%
0%
0
10
20
30
40
50
60
70
80
Final Earnings Multiple
®
Source: Employee Benefit Research Institute, Ballpark E$timate Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
16
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
2
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
% of Equity
Investment
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
65%
62
59
55
55
90
81
78
80
78
120
108
105
105
117
0%
122%
111
105
101
99
178
157
151
146
142
241
213
209
219
237
65%
61
59
57
56
83
79
75
74
75
104
101
98
98
105
25%
119%
113
105
101
100
158
151
143
143
144
213
194
182
195
213
63%
61
59
59
57
81
78
74
74
73
98
93
94
89
91
63%
61
61
59
58
77
74
74
71
72
92
88
86
85
88
Annuitization Level
50%
75%
114%
113%
112
112
105
108
106
109
103
106
151
144
146
141
140
134
139
136
141
134
188
177
180
172
178
155
179
160
179
167
62%
61
61
61
60
74
72
72
71
70
87
85
82
82
80
100%
112%
111
110
110
109
137
137
130
132
133
166
160
153
156
153
4
Income
Category
3
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
Probability
of Adequacy
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
% of Equity
Investment
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
50%
46
42
41
40
68
59
58
55
57
87
76
76
78
86
0%
56%
52
49
47
47
75
69
65
64
66
102
91
87
91
105
48%
45
44
42
42
60
57
55
54
56
74
72
67
70
75
25%
55%
52
50
49
48
71
67
63
63
65
91
83
80
83
88
47%
46
43
43
42
57
55
53
53
53
67
66
63
63
66
Annuitization Level
50%
54%
52
51
50
49
67
63
61
62
62
79
76
75
75
76
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
Probability
of Adequacy
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
For: Males Retiring at Age 65
47%
45
45
44
44
55
53
51
53
51
63
61
59
59
59
75%
53%
52
51
51
50
63
63
62
60
60
75
74
72
71
71
46%
46
46
45
45
52
52
51
51
51
58
58
58
58
58
100%
52%
52
52
52
51
62
61
60
60
59
72
71
69
69
67
Figure 12
Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income Category, Equity Allocation, and Rate of Annuitization
Income
Category
1
17
Figure 13
Impact of Replacement Rates on Probability of
"Adequate" Retirement Income, by Rate of Annuitization
(Assumes Lowest Income Category and No Equity Investment)
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
70%
0% Annuitization
60%
25% Annuitization
50%
50% Annuitization
40%
75% Annuitization
30%
100% Annuitization
20%
10%
0%
0%
100%
200%
300%
400%
500%
600%
700%
Replacement Rate
®
Source: Employee Benefit Research Institute, Ballpark E$timate Monte Carlo, August 2006 version.
Conclusion
Most Americans have always been on their own when it comes to savings and the ability to retire well.
Since 1937, Social Security has provided a base level of income for those workers who reached retirement
age, became disabled, or their survivors. With an average income replacement rate around 40 percent, Social
Security was never designed to be the sole source of income. The Internet age for the first time makes
savings planning tools readily available to all individuals. All workers can open an individual retirement
account, and savings tools can help them determine how much they need to save. The same is true for
workers who have a 401(k) or similar savings plan at work.
It has always been important for most employees or their advisors to be able to construct a savings plan
for retirement that will allow them to determine, inter alia, the appropriate savings rates at an early age.
There are various financial programs and calculators available to assist employees with this process, but
many of them require the user to input a desired replacement rate or its equivalent. Although there have been
many studies that provide readily available rules of thumb, often these are based on methodologies limited to
replacement of preretirement cash flow after adjustment for taxes, savings and age and/or work-related
expenses.
One of the most problematic aspects of using the results of these models is that one or more of the most
important retirement risks is ignored: investment risk, longevity risk, and risk of potentially catastrophic
health care costs. The Ballpark E$timate® Monte Carlo Web site that EBRI and its American Savings
Education Council and Choose to Save® programs will make available to the public in coming months, at
www.choosetosave.org, specifically addresses each of these risks and allows the user to determine what
replacement rate (or initial retirement wealth expressed in either dollar values or a multiple of earnings
approach) will provide a 50-, 75-, or 90 percent chance of successfully providing a specified amount of nonhealth retirement expenditures as well as simulated health care expenses. Users will be able to construct
individualized "what-if" scenarios that will provide instant feedback on the changes in replacement rates,
dollar values, or multiples of earnings required as a result of changing retirement age, asset allocation, and/or
percentage of initial retirement wealth annuitized.24
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
18
How much of a difference will this process make in the initial determination of a target replacement rate?
If it is assumed that there is no equity allocation of assets nor is any of the initial retirement wealth
annuitized, the stylized high-income category male modeled in this Issue Brief would need a 52 percent
replacement rate in order to have a 50 percent chance of covering his retirement expenses if he retires at age
65.25 If he is not comfortable with a 50–50 prospect of "running out" of retirement income, he could increase
his chances of success to 75 percent by raising his income replacement rate to 78 percent; if he wants a 90
percent chance of success, he would have to raise his replacement rate to 119 percent.
What would it mean if this high-income male took early retirement as soon as he is eligible for Social
Security (age 62)? The replacement rates jump considerably: For a 50–50 chance of success, his income
replacement rate would be 64 percent; for a 75 percent chance of success, his replacement rate is 97 percent;
and for a 90 percent chance of success, his replacement rate is 149 percent. If, on the other hand, he decides
to delay retirement until age 68, he can decrease the figures to 43, 66, and 97 percent, respectively.
The same simulations for the stylized low-income category male would require significantly larger
replacement rates, since non-health care retirement expenditures are not reduced proportionally with
retirement income nor is the health care expense typically a function of income. In this case, a low-income
male retiring at 65 would have to replace 124 percent of his annual income just for a 50 percent chance of
success, while a 75 percent chance requires a replacement rate of 229 percent; for a 90 percent chance of
success, he would require a huge increase in the replacement rate to 394 percent! Similar modifications for
early and late retirement would take place at this income level.
Whether a significant percentage of workers will be able to accumulate sufficient retirement wealth to
achieve these replacement rate targets is a question that requires separate modeling. EBRI is currently in the
process of updating the EBRI/ERF Retirement Security Projection Model® to account for the changes
recently enacted in the Pension Protection Act of 2006 and will use the projected retirement accumulations
from that model to determine the impact on various demographic groups under a variety of assumptions with
respect to plan sponsor and plan participant reactions to the new provisions.26
As longevity continues to increase, as health expenses continue to climb, and as Social Security
replacement rates slowly decline, the need for individuals to save for retirement has never been greater. The
need has always been great for detail beyond a “rule-of-thumb” replacement target of “75 to 85 percent,” but
only now are free tools being made broadly available via the Internet so that all individuals have the
opportunity to do the needed planning without the necessity of seeking professional advice.
References
Alford, Susan, D. Bryan Farnen, and Mike Schachet. “Light At The End Of The Tunnel: Getting On Track
for Affordable Retirement.” Benefits Quarterly (4th Quarter, 2004).
Ameriks, John, Robert Veres, and Mark J. Warshawsky. “Making Retirement Income Last a Lifetime.”
Journal of Financial Planning (December 2001).
Fronstin, Paul. “Savings Needed to Fund Health Insurance and Health Care Expenses in Retirement.” EBRI
Issue Brief no. 295 (Employee Benefit Research Institute, July 2005).
Holden, Sarah, and Jack VanDerhei. “The Influence of Automatic Enrollment, Catch-Up and IRA
Contributions on 401(k) Accumulations in Retirement.” EBRI Issue Brief no. 283 (Employee Benefit
Research Institute, July 2005).
Hurd, Michael D., and Susann Rohwedder. “Alternative Measures of Replacement Rates.” Prepared for the
8th Annual Joint Conference for the Retirement Research Consortium, “Pathways to a Secure
Retirement.” August 10–11, 2006.
Schieber, Sylvester J. “Conceptual and Measurement Problems in Contemporary Measures of Income Needs
in Retirement.” Benefits Quarterly. Vol. 12, no. 2 (Second Quarter 1996): 56–68.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
19
____. “Deriving Preretirement Income Replacement Rate Targets and the Savings Rates Needed to Meet
Them.” Benefits Quarterly. Vol. 14, no. 2 (Second Quarter 1998): 53–69.
Steinberg, Allen and Lori Lucas. “Shifting Responsibility: The Future of Retirement Adequacy In America.”
Benefits Quarterly (4th Quarter, 2004).
VanDerhei, Jack, and Craig Copeland. “Can America Afford Tomorrow’s Retirees: Results From the EBRIERF Retirement Security Projection Model.” EBRI Issue Brief no. 263 (Employee Benefit Research
Institute, November 2003).
VanDerhei, Jack. “Measuring Retirement Income Adequacy, Traditional Replacement Ratios, and Results
for Workers at Large Companies.” EBRI Notes, no. 9 (Employee Benefit Research Institute, September
2004).
Endnotes
1
Indeed, the choice of a replacement rate is often the first step in determining the appropriate savings rate during the
accumulation process. See the interactive Ballpark E$stimate at http://choosetosave.org/ballpark/ for an example.
2
A method for computer modeling based on chance; a technique for producing distributions of outcomes of stochastic
(variable) processes by running many iterations of the model process. Distinct from “deterministic” projections, which
are based on set assumptions that exclude the possibility of variation.
3
The terms adequate or adequacy when used to describe the results in this Issue Brief refer to whether there was
sufficient retirement income under a simulated set of circumstances to allow the individual to maintain a pre-specified
consumption pattern in retirement as well as the ability to afford simulated health care expenditures. The consumption
patterns used in the four hypothetical examples are averages from government surveys and in no way represent a value
judgment on whether these amounts are sufficient in a social welfare context. Nor do they necessarily reflect an
individual's perception of adequacy. However, the Web version of the model will allow an individual to choose what he
or she believes to be an adequate level of expenses.
4
Currently, the model is designed only to simulate results for individuals, but a future version of the model will allow
families to use the model in an integrated manner.
5
The model also differentiates the calculations based on whether the retiree rents or owns a house and, if the latter,
whether there is still a mortgage on the house at the time of retirement
6
Currently, the only option in the model is to purchase an immediate annuity at retirement. Further enhancements are
currently in the planning stages, including the use of longevity insurance.
7
For purposes of simplicity, the analysis in this Issue Brief assumes the retiree does not have an accrued benefit from a
defined benefit plan. However, the lump-sum equivalent of the benefit could be computed to use with this analysis.
8
In most cases, it is assumed that the vast majority of the initial retirement wealth is composed of 401(k) and IRA
balances that are not Roth variants of these programs. Although the program allows input of both taxable and nontaxable amounts, for purposes of the Issue Brief it is assumed that all amounts other than certain specified amounts of
Social Security benefits will be subject to federal income tax.
9
The numbers illustrated in this Issue Brief are based on 1,000 simulated life paths.
10
In reality, retirees may be forced to decrease their consumption instead.
11
This is defined as life expectancy for Building Block 1 approach (below) and a stochastic age for Building Blocks 2
and 3.
12
It is important to realize that this methodology is implicitly adding a nominal annuity to a real annuity; however, the
purchase of the latter appears to be de minimis. The Web version of the program will allow real annuities to be selected
for the initial retirement wealth if the user prefers.
13
This option was chosen to reflect a guaranteed investment contract (GIC) or stable value option, where the rate of
return realized is net of expenses.
14
The Consumer Expenditure Survey (CES) is conducted by the Bureau of Labor Statistics of the U.S. Department of
Labor. The survey targets the total noninstitutionalized population (urban and rural) of the United States and is the basic
source of data for revising the items and weights in the market basket of consumer purchases to be priced for the
Consumer Price Index. The CES data allow for the total expenditures that these elderly individuals make annually by
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
20
gender and home ownership. The expenditures used in this study are the total expenditures net of health care costs for
just the single individuals of the respective genders.
15
Hurd and Rohwedder (2006) report 2001 CES expenditure averages of $31,700 for those aged 65−74 and $22,800 for
those age 75 or over. These numbers include health care expenditures and include expenditures from families. They also
compare these numbers with those derived from the Consumption and Activities Mail Survey (CAMS) and find larger
expenditure averages: 12 percent larger for the younger group and 30 percent larger for the older group. The authors
speculate the differences may be due to the problem of the reference person and the difference in numbers reflects a
difference in the populations represented. We are unable to discern which set of expenditure numbers are likely to be
more representative; however, it is clear that the replacement rates derived in this study for any specific set of
circumstances would increase if the CAMS expenditure numbers were used.
16
A link to the benefits estimators on the SSA.gov Web site will be provided in the Web site interface.
17
The estimates were a national average of monthly nursing home costs found from the NNHS. The NNHS is a
nationwide sample survey of nursing homes, their current residents and discharges that was conducted by the National
Center for Health Statistics from July through December 1999.
The home health care use, length of stay (use), and monthly expenses were determined from the 2000 National Home
and Hospice Care Survey (NHHCS). The NHHCS is a nationwide sample survey of home health and hospice care
agencies, their current and discharged patients that was conducted by the National Center for Health Statistics from
August through December 2000.
18
19
We utilized the CareFirst BlueChoice HMO HIPAA plan quotes for the Washington, DC area from their Web site in
2006.
20
No state or local income tax is assumed in this Issue Brief, but Web users will be able to input values to override the
default values.
21
This evaluation feature will be added to the model once we determine the best way to introduce actual or generic
long-term care insurance policy parameters and pricing information into the model.
22
Figure 7 provides detailed information for all four retirement income categories.
23
Ameriks, Veres, and Warshawsky (2001) found similar interactions.
24
Future versions of the model will also allow for the purchase of either generic or specific long-term care insurance
policies.
25
The requisite replacement rates for females would be slightly larger in each instance due to their longer life
expectancies.
26
One potentially positive note for future retirement income adequacy deals with the automatic enrollment provisions in
the pension reform law. Holden and VanDerhei (2005) used a similar simulation technique to predict the impact of
various combinations of default contributions and default asset allocations on future 401(k) account balances. The one
that most closely approximates the provisions in the legislation provided increases of 126 percent in the average account
balances for those in the lowest income quartile of all 401(k) participants.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
21
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
22
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
Probability of % of Equity
Adequacy
Investment
50%
0%
50
25
50
50
50
75
50
100
75%
0%
75
25
75
50
75
75
75
100
90%
0%
90
25
90
50
90
75
90
100
65%
62
59
55
55
90
81
78
80
78
120
108
105
105
117
0%
122%
111
105
101
99
178
157
151
146
142
241
213
209
219
237
65%
61
59
57
56
83
79
75
74
75
104
101
98
98
105
25%
119%
113
105
101
100
158
151
143
143
144
213
194
182
195
213
63%
61
59
59
57
81
78
74
74
73
98
93
94
89
91
Annuitization
50%
114%
112
105
106
103
151
146
140
139
141
188
180
178
179
179
63%
61
61
59
58
77
74
74
71
72
92
88
86
85
88
75%
113%
112
108
109
106
144
141
134
136
134
177
172
155
160
167
62%
61
61
61
60
74
72
72
71
70
87
85
82
82
80
100%
112%
111
110
110
109
137
137
130
132
133
166
160
153
156
153
4
Income
Category
3
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
Probability of % of Equity
Adequacy
Investment
50%
0%
50
25
50
50
50
75
50
100
75%
0%
75
25
75
50
75
75
75
100
90%
0%
90
25
90
50
90
75
90
100
50%
46
42
41
40
68
59
58
55
57
87
76
76
78
86
0%
56%
52
49
47
47
75
69
65
64
66
102
91
87
91
105
48%
45
44
42
42
60
57
55
54
56
74
72
67
70
75
25%
55%
52
50
49
48
71
67
63
63
65
91
83
80
83
88
47%
46
43
43
42
57
55
53
53
53
67
66
63
63
66
Annuitization
50%
54%
52
51
50
49
67
63
61
62
62
79
76
75
75
76
47%
45
45
44
44
55
53
51
53
51
63
61
59
59
59
75%
53%
52
51
51
50
63
63
62
60
60
75
74
72
71
71
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
2
Income
Category
1
For: Males Retiring at Age 65
46%
46
46
45
45
52
52
51
51
51
58
58
58
58
58
100%
52%
52
52
52
51
62
61
60
60
59
72
71
69
69
67
Figure 14
Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income Category, Equity Allocation, and Rate of Annuitization
Figure 15
Impact of Defined Contribution Balance on Probability
of "Adequate" Retirement Income, by Annuitization
(Assumes 0% Equity Allocation)
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
Annuitization
Percentage
70%
60%
0%
50%
25%
40%
50%
75%
100%
30%
20%
10%
$$1
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
Figure 16
Impact of Defined Contribution Balance on Probability
of "Adequate" Retirement Income, by Annuitization
(Assumes 50% Equity Allocation)
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
70%
Annuitization
Percentage
60%
0%
25%
50%
75%
100%
50%
40%
30%
20%
10%
$1
$0
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
23
Figure 17
Impact of Defined Contribution Balance on Probability
of "Adequate" Retirement Income, by Annuitization
(Assumes 0% Equity Allocation)
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probability of Adequacy
80%
Annuitization
Percentage
70%
60%
0%
50%
25%
50%
40%
75%
100%
30%
20%
10%
0,
00
$1
0
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0,
00
0
$9
0
0,
00
0
$8
0
0,
00
0
$7
0
0,
00
0
$6
0
0,
00
0
$5
0
0,
00
0
$4
0
0,
00
0
$3
0
$2
0
$-
$1
0
0,
00
0
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 18
Impact of Defined Contribution Balance on Probability of
"Adequate" Retirement Income, by Annuitization
(Assumes 50% Equity Allocation)
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
Probabilityd of Adequacy
80%
Annuitization
Percentage
70%
0%
60%
25%
50%
50%
40%
75%
30%
100%
20%
10%
$0
$1
00
,0
00
$2
00
,0
00
$3
00
,0
00
$4
00
,0
00
$5
00
,0
00
$6
00
,0
00
$7
00
,0
00
$8
00
,0
00
$9
00
,0
00
$1
,0
00
,0
00
$1
,1
00
,0
00
$1
,2
00
,0
00
$1
,3
00
,0
00
$1
,4
00
,0
00
$1
,5
00
,0
00
$1
,6
00
,0
00
$1
,7
00
,0
00
$1
,8
00
,0
00
$1
,9
00
,0
00
$2
,0
00
,0
00
0%
Initial Retirement Wealth
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
24
Figure 19
Replacement Ratios Required for a 50% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
140%
120%
Replacement Rate
100%
Equity Level
80%
0%
25%
60%
50%
75%
40%
100%
20%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 20
Replacement Ratios Required for a 75% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
200%
180%
160%
Replacement Rate
140%
120%
Equity Allocation
100%
0%
25%
80%
50%
60%
75%
100%
40%
20%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
25
Figure 21
Replacement Ratios Required for a 90% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
300%
250%
Replacement Rate
200%
150%
Equity Level
0%
100%
25%
50%
75%
50%
100%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 22
Replacement Ratios Required for a 50% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
60%
50%
Replacement Rate
40%
Equity Level
30%
0%
25%
20%
50%
75%
100%
10%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
26
Figure 23
Replacement Ratios Required for a 75% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
80%
70%
Replacement rate
60%
50%
Equity Level
40%
0%
25%
30%
50%
20%
75%
100%
10%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 24
Replacement Ratios Required for a 90% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 2 (investment income and longevity stochastic, health care expenses deterministic)
100%
90%
80%
Replacement Rate
70%
60%
Equity Level
50%
0%
40%
25%
50%
30%
75%
20%
100%
10%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
27
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
28
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
62%
61
62
58
58
114
104
99
93
92
142
135
133
130
138
64%
61
59
59
57
110
103
95
89
85
160
156
143
143
149
65%
63
60
59
58
120
103
91
93
92
180
160
148
155
168
63%
62
58
59
59
117
104
100
89
88
155
141
132
124
141
Annuitization Level
25%
50%
75%
124%
111%
111%
114
112
111
110
105
105
102
109
107
102
106
105
229
228
224
215
205
208
184
186
205
176
177
187
176
175
177
394
301
291
296
293
280
290
283
269
289
268
281
301
293
286
0%
124%
115
109
104
105
229
210
195
175
179
394
335
302
289
353
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
2
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
Income
Probability % of Equity
Category of Adequacy Investment
50%
0%
1
For: Males Retiring at Age 65
61%
60
59
59
58
113
108
100
95
93
145
134
141
131
142
100%
111%
102
103
101
103
227
212
197
191
178
302
292
290
284
292
4
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
Income
Probability % of Equity
Category of Adequacy Investment
3
50%
0%
52%
48
43
43
43
78
70
66
63
67
119
107
96
98
111
0%
56%
53
51
50
50
97
89
80
74
79
152
125
125
121
132
51%
46
45
43
43
74
66
63
62
62
106
96
90
92
97
47%
47
45
45
43
72
69
62
59
63
94
89
87
87
84
47%
45
45
44
44
72
69
65
62
58
89
82
84
80
83
Annuitization Level
25%
50%
75%
56%
53%
52%
52
52
51
51
50
51
50
51
50
50
51
50
98
93
94
85
84
86
78
81
82
76
76
76
76
72
73
135
121
118
116
115
111
112
110
109
108
111
109
119
111
106
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
45%
45
44
45
45
71
69
67
63
61
87
88
85
87
86
100%
51%
51
50
51
50
90
86
82
80
74
122
113
109
112
112
Figure 25
Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income Category, Equity Allocation, and Rate of Annuitization
Figure 26
Impact of Final Earnings Multiple on the Probability of
Retirement Income "Adequacy," by Retirement Income Category
(Assumes 100% Equity Allocation and No Annuitization)
For: Males Retiring at Age 65
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
100%
90%
Probability of Adequacy
80%
70%
Low Income
60%
50%
HIgh Income
40%
30%
20%
10%
0%
0
10
20
30
40
50
60
70
80
Final Earnings Multiple
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
29
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
30
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
2
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
% of Equity
Investment
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
79%
70
70
66
65
147
124
112
107
108
204
187
172
162
199
0%
147%
135
131
122
114
292
238
214
206
216
453
373
348
364
374
76%
74
67
66
64
135
118
108
106
103
192
167
162
158
162
25%
141%
142
124
119
116
276
237
212
200
212
411
358
320
318
368
74%
73
67
70
66
130
119
110
101
105
170
157
144
149
146
70%
70
69
66
64
126
115
110
104
101
158
152
139
147
140
Annuitization Level
50%
75%
143%
135%
129
122
133
128
118
118
121
118
258
256
231
234
215
221
205
211
202
199
382
337
313
316
306
299
312
281
313
307
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
Probability
of Adequacy
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
Income
Category
1
For: Females Retiring at Age 65
71%
69
66
63
63
121
117
110
108
112
159
169
153
148
152
100%
138%
123
118
118
116
247
228
223
218
198
338
316
311
287
309
4
Income
Category
3
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
Probability % of Equity
of Adequacy Investment
50%
0%
50
25
50
50
50
75
50
100
75%
0%
75
25
75
50
75
75
75
100
90%
0%
90
25
90
50
90
75
90
100
59%
51
49
47
46
98
79
73
69
69
128
113
103
116
125
0%
71%
61
58
56
53
118
100
95
88
89
171
148
139
138
157
55%
52
51
48
47
88
77
71
67
69
117
107
100
101
108
25%
65%
60
60
58
55
113
98
89
86
85
155
134
128
134
136
53%
53
51
48
48
85
76
71
67
67
106
99
93
94
97
Annuitization Level
50%
63%
59
58
57
56
104
97
89
85
82
138
129
118
118
122
50%
53
50
48
48
80
75
70
69
69
99
90
90
90
93
75%
60%
60
64
59
55
103
96
93
86
87
132
124
112
122
117
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
51%
50
50
49
49
77
74
71
70
69
102
96
92
93
93
100%
61%
58
58
57
56
99
94
92
89
90
129
123
124
121
121
Figure 27
Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income Category, Equity Allocation, and Rate of Annuitization
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
31
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
2
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
% of Equity
Investment
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
85%
83
75
72
70
139
128
121
110
109
234
203
186
188
198
0%
153%
139
135
126
124
285
259
225
222
231
476
398
391
393
419
82%
80
75
72
71
139
124
112
114
109
208
192
164
165
171
25%
150%
142
124
133
126
290
232
227
210
205
421
372
342
343
354
79%
77
75
74
73
136
127
113
112
109
179
165
162
157
167
79%
75
74
75
74
136
128
118
108
104
175
160
158
158
159
Annuitization Level
50%
75%
143%
136%
139
134
129
134
128
129
131
126
249
268
240
248
220
233
209
207
215
210
373
339
351
313
319
310
329
313
330
329
75%
75
73
74
74
130
125
120
120
116
182
163
158
162
167
100%
131%
126
127
126
127
265
244
228
224
218
358
322
321
323
335
4
Income
Category
3
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
Probability
of Adequacy
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
% of Equity
Investment
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
64%
61
56
52
50
97
89
81
84
81
149
125
122
124
127
0%
75%
68
65
62
63
118
109
98
96
99
196
163
155
153
176
62%
58
57
53
55
90
83
76
78
78
130
114
108
110
116
25%
70%
68
65
63
64
110
106
95
93
91
164
145
142
141
143
60%
59
57
55
54
91
81
76
76
71
121
107
103
107
104
Annuitization Level
50%
69%
66
64
65
62
114
103
96
94
87
151
139
136
127
128
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
Probability
of Adequacy
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
Income
Category
1
For: Males Retiring at Age 62
59%
57
56
56
55
90
82
78
75
74
111
98
98
96
105
75%
68%
64
65
64
63
113
104
100
92
91
114
132
126
128
129
56%
56
55
55
56
87
81
78
77
75
111
108
102
102
102
100%
64%
64
63
64
63
107
105
99
96
91
141
137
122
138
136
Figure 28
Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income Category, Equity Allocation and Rate of Annuitization
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
32
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
2
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
% of Equity
Investment
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
93%
89
91
87
90
199
192
175
152
150
292
271
250
256
249
51%
51
51
50
50
94
91
81
83
79
141
129
113
122
129
53%
52
50
50
51
110
96
83
80
83
156
141
127
139
121
25%
95%
95
87
91
91
206
184
167
153
157
332
290
268
280
297
0%
52%
50
51
49
51
99
95
97
82
76
125
121
115
115
126
92%
89
90
90
87
203
185
165
165
158
266
242
236
225
235
53%
52
51
50
51
98
92
88
86
80
123
116
115
111
122
93%
90
91
90
90
200
191
175
160
155
261
242
244
251
237
Annuitization Level
50%
75%
51%
52
50
52
51
100
92
89
84
83
121
125
120
118
118
93%
92
90
91
90
196
190
176
168
154
258
256
246
238
240
100%
4
3
Income
Category
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
Probability
of Adequacy
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
% of Equity
Investment
0%
25
50
75
100
0%
25
50
75
100
0%
25
50
75
100
43%
40
39
38
37
66
60
55
55
56
97
86
85
85
96
46%
46
44
43
44
77
77
66
63
64
123
111
100
104
111
0%
41%
39
39
38
37
60
60
55
53
52
89
79
83
79
75
45%
43
43
43
43
76
76
67
66
63
112
101
95
94
104
25%
39%
39
38
38
38
62
60
57
52
52
81
77
73
73
76
45%
43
43
43
43
82
76
71
68
67
104
97
95
91
98
39%
38
38
38
39
63
62
59
57
52
76
73
73
73
74
44%
43
43
43
43
81
76
75
70
64
101
96
96
100
93
Annuitization Level
50%
75%
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
Source: Employee Benefit Research Institute, Ballpark E$timate ® Monte Carlo, August 2006 version.
1
Probability
of Adequacy
50%
50
50
50
50
75%
75
75
75
75
90%
90
90
90
90
Income
Category
For: Males Retiring at Age 68
38%
38
38
38
38
62
61
58
56
54
74
73
73
73
73
43%
44
43
43
43
79
77
71
70
67
96
100
95
95
100
100%
Figure 29
Impact of Replacement Rates on Probability of "Adequate" Retirement Income, by Income Category, Equity Allocation, and Rate of Annuitization
Figure 30
Replacement Ratios Required for a 50% Chance of "Adequacy"
For: Males Retiring at Age 65, Lowest Income Category
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
140%
120%
Replacement Rate
100%
80%
Equity Allocation
60%
0%
25%
40%
50%
75%
100%
20%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 31
Replacement Ratios Required for a 75% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
250%
Replacement Rate
200%
150%
Equity Allocation
0%
100%
25%
50%
75%
50%
100%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
33
Figure 32
Replacement Ratios Required for a 90% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Lowest Income Category
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
450%
400%
350%
Replacement Rate
300%
250%
200%
Equity Allocation
0%
150%
25%
50%
100%
75%
100%
50%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 33
Replacement Ratios Required for a 50% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
60%
50%
Replacement Rate
40%
30%
Equity Level
No Equity
25%
20%
50%
75%
All Equity
10%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
34
Figure 34
Replacement Ratios Required for a 75% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 3 (investment income, longevity, and health care expenses stochastic)
90%
80%
70%
Replacement Rate
60%
50%
Equity Level
40%
0%
25%
30%
50%
75%
20%
100%
10%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
Figure 35
Replacement Ratios Required for a 90% Chance of "Adequacy"
For: Males Retiring at Age 65 in the Highest Income Category
Option: Building Block 3 (investment income, longevity, and health care stochastic)
140%
120%
Replacement Rate
100%
80%
60%
Equity Allocation
0%
40%
25%
50%
75%
20%
100%
0%
0%
25%
50%
75%
100%
Degree of Annuitization
Source: Employee Benefit Research Institute, Ballpark E$timate® Monte Carlo, August 2006 version.
EBRI Issue Brief No. 297 • September 2006 • www.ebri.org
35
EBRI Issue Brief
EBRI Employee Benefit Research Institute Issue Brief (ISSN 0887−137X) is published monthly by the Employee Benefit Research Institute,
2121 K Street, NW, Suite 600, Washington, DC 20037-1896, at $300 per year or is included as part of a membership subscription.
Periodicals postage rate paid in Washington, DC, and additional mailing offices. POSTMASTER: Send address changes to: EBRI Issue
Brief, 2121 K Street, NW, Suite 600, Washington, DC 20037-1896. Copyright 2006 by Employee Benefit Research Institute. All rights
reserved, No. 297.
Who we are
What we do
Our
publications
Orders/
subscriptions
The Employee Benefit Research Institute (EBRI) was founded in 1978. Its mission is to
contribute to, to encourage, and to enhance the development of sound employee benefit
programs and sound public policy through objective research and education. EBRI is the only
private, nonprofit, nonpartisan, Washington, DC-based organization committed exclusively to
public policy research and education on economic security and employee benefit issues.
EBRI’s membership includes a cross-section of pension funds; businesses; trade associations;
labor unions; health care providers and insurers; government organizations; and service firms.
EBRI’s work advances knowledge and understanding of employee benefits and their
importance to the nation’s economy among policymakers, the news media, and the public. It
does this by conducting and publishing policy research, analysis, and special reports on
employee benefits issues; holding educational briefings for EBRI members, congressional and
federal agency staff, and the news media; and sponsoring public opinion surveys on employee
benefit issues. EBRI’s Education and Research Fund (EBRI-ERF) performs the charitable,
educational, and scientific functions of the Institute. EBRI-ERF is a tax-exempt organization
supported by contributions and grants.
EBRI Issue Brief is a periodical providing expert evaluations of employee benefit issues and
trends, as well as critical analyses of employee benefit policies and proposals. EBRI Notes is a
periodical providing current information on a variety of employee benefit topics. EBRI’s
Pension Investment Report provides detailed financial information on the universe of defined
benefit, defined contribution, and 401(k) plans. EBRI Fundamentals of Employee Benefit
Programs offers a straightforward, basic explanation of employee benefit programs in the
private and public sectors. EBRI Databook on Employee Benefits is a statistical reference
volume on employee benefit programs and work force related issues.
Contact EBRI Publications, (202) 659-0670; fax publication orders to (202) 775-6312.
Subscriptions to EBRI Issue Briefs are included as part of EBRI membership, or as part of a
$199 annual subscription to EBRI Notes and EBRI Issue Briefs. Individual copies are available
with prepayment for $25 each (for printed copies) or for $7.50 (as an e-mailed electronic file)
by calling EBRI or from www.ebri.org. Change of Address: EBRI, 2121 K Street, NW, Suite
600, Washington, DC 20037, (202) 659-0670; fax number, (202) 775-6312; e-mail:
Publications Subscriptions@ebri.org. Membership Information: Inquiries regarding EBRI
membership and/or contributions to EBRI-ERF should be directed to EBRI President/ASEC
Chairman Dallas Salisbury at the above address, (202) 659-0670; e-mail: salisbury@ebri.org
Editorial Board: Dallas L. Salisbury, publisher; Steve Blakely, editor. Any views expressed in this publication and those of the authors should
not be ascribed to the officers, trustees, members, or other sponsors of the Employee Benefit Research Institute, the EBRI Education and
Research Fund, or their staffs. Nothing herein is to be construed as an attempt to aid or hinder the adoption of any pending legislation, regulation,
or interpretative rule, or as legal, accounting, actuarial, or other such professional advice.
EBRI Issue Brief is registered in the U.S. Patent and Trademark Office. ISSN: 0887−137X/90 0887−137X/90 $ .50+.50
Did you read this as a pass-along? Stay ahead of employee benefit issues with your own subscription to EBRI
Issue Brief for only $89/year electronically e-mailed to you or $199/year printed and mailed. For more information
about subscriptions, visit our Web site at www.ebri.org or complete the form below and return it to EBRI.
Name
Organization
Address
City/State/ZIP
Mail to: EBRI, 2121 K Street, NW, Suite 600, Washington, DC 20037 or Fax to: (202) 775-6312
© 2006, Employee Benefit Research Institute−Education and Research Fund. All rights reserved.