Measuring Retirement Income Adequacy, Part One: Traditional Replacement Ratios and Results for Workers at Large Companies

Abstract

This paper is the first of a two-part series intended to sort through some of the issues and variations in determining whether the post-World War II baby boom generation is likely to achieve an "acceptable" standard of living in retirement. A recent study by Hewitt Associates shows that the typical 401(k) participant is well-positioned to replace 85-95 percent of preretirement income when current Social Security, existing profit-sharing, and defined benefit plans are taken into account. The study examined the projected preretirement income replacement levels across 62 large companies of the 960,000 employees who were actively participating in their 401(k) plans as of January 1, 2003. The overall average replacement ratio for the Hewitt 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 an even larger financial setback.

Keywords: Income replacement rate, Postretirement expenditures, Retirement income

JEL Classification: D31, D91, J14