Alternate Measures of Replacement Rates for Social Security Benefits and Retirement Income

Social Security Bulletin, Vol. 68, No. 2, 2008

19 Pages Posted: 17 Nov 2008

See all articles by Glenn Springstead

Glenn Springstead

Social Security Administration

Andrew G. Biggs

American Enterprise Institute

Date Written: November 1, 2008

Abstract

Discussions of retirement planning and Social Security policy often focus on replacement rates, which represent retirement income or Social Security benefits relative to pre-retirement earnings. Replacement rates are a rule of thumb designed to simplify the process of smoothing consumption over individuals' lifetimes. Despite their widespread use, however, there is no common means of measuring replacement rates. Various measures of pre-retirement earnings mean that the denominators used in replacement rate calculations are often inconsistent and can lead to confusion.

Whether a given replacement rate represents an adequate retirement income depends on whether the denominator in the replacement rate calculation is an appropriate measure of pre-retirement earnings. This article illustrates replacement rates using four measures of pre-retirement earnings: final earnings; the constant income payable from the present value (PV) of lifetime earnings (PV payment); the wage-indexed average of all earnings prior to claiming Social Security benefits; and the inflation-adjusted average of all earnings prior to claiming Social Security benefits (consumer price index (CPI) average).

The article then measures replacement rates against a sample of the Social Security beneficiary population using the Social Security Administration's Modeling Income in the Near Term (MINT) microsimulation model. Replacement rates are shown based on Social Security benefits alone, to indicate the adequacy of the current benefit structure, as well as on total retirement income including defined benefit pensions and financial assets, to indicate total preparedness for retirement.

The results show that replacement rates can vary considerably based on the definition of pre-retirement earnings used and whether replacement rates are measured on an individual or a shared basis. For current new retirees, replacement rates based on all sources of retirement income seem strong by most measures and are projected to remain so as these individuals age. For new retirees in 2040, replacement rates are projected to be lower, though still adequate on average based on most common benchmarks.

Keywords: replacement rate, Social Security, retirement income

JEL Classification: H55, J26

Suggested Citation

Springstead, Glenn and Biggs, Andrew G., Alternate Measures of Replacement Rates for Social Security Benefits and Retirement Income (November 1, 2008). Social Security Bulletin, Vol. 68, No. 2, 2008, Available at SSRN: https://ssrn.com/abstract=1299029

Glenn Springstead

Social Security Administration ( email )

Washington, DC 20254
United States

Andrew G. Biggs (Contact Author)

American Enterprise Institute ( email )

1150 17th Street N.W.
Washington, DC 20036
United States
202-862-5841 (Phone)

HOME PAGE: http://www.aei.org

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