Whereas in 2001 workers earning $20,000-a-year needed 83% or their preretirement income for a comfortable retirement, the replacement ratio – a person’s gross income after retirement divided by their gross income before retirement – has gone up to 89% in 2004. Similarly, the $80,000-a-year earner needed 75% in 2001 now that ratio has been bumped up to 77%, according to the Aon Consulting/Georgia State University Replacement Ratio Study.
One reason for the increase noted by Aon is tax cuts, s ince paying less tax increases a person’s pre-retirement disposable income, which increases the amount of post-retirement income he or she needs to maintain the same level of disposable income after retirement. For example, a $20,000 wage earner pays 28% less in taxes in 2004 than in 2001.
Yet even as the lower income bracket’s retirement liability is headed north, their savings rates are going south. In 1997, workers age 50-65, earning $20,000 a year, saved on average 4.4% of their gross pre-retirement income; a figure that fell to 1.4% in 2001 and 0.7% in 2004. This group is not alone, as even those in the $90,000 annual salary bracket saw savings as a percentage of gross income decline from 1997’s 5.0% to 2004’s 2.1%.
Not surprisingly, given the numbers,Aon research finds that 41% of American workers don’t think they will have enough money to retire, and 32% “don’t know.”
“Understanding replacement ratios is just one step for employers to undertake as they help their employees plan for retirement,” continued Ron DeStefano, senior vice president with Aon Consulting. “The next step is to use those percentages to take a serious look at where the employee population falls at their organization. If a company has a large portion of employees that are not ‘on track’ for retirement, it’s vital to analyze issues such as plan design and communication of plan benefits.”
In the study, Aon found replacement ratios in 2004 ranged from 89% for those workers making $20,000 a year prior to retirement to 78% for employees in the $90,000 annual pay range. By retirement income stream, workers making $20,000 dollars a year can expect 65% of their total replacement income from Social Security, compared to only 33% for workers at the top end of the scale. On the other side, those making $90,000 annually prior to retirement are expected to chip in 45% of the postretirement income, compared to only 24% of the lower income earners Aon said Social Security replacing a larger portion of preretirement income at lower wage levels is “by design and has the effect of redistributing incomefrom higher paid employees to lower paid.”
However, the ratios tend to be the highest for those workers on the low end of the pay scale, since this group tends to save the least and pay the least in taxes before retirement. Thus, Aon concludes, the lower wage earners spend a higher percentage of their income and need higher replacement ratios to maintain that level of expenditures.
The ideal replacement ratio appears to be at a $60,000 annual salary. At this level, social security benefits are expected to provide 43% of the employee’s preretirement income and private and employer sources provide 32%, equaling a replacement ratio of 75% for this group. After reaching an income level of $60,000, total replacement ratios begin to increase slowly, primarily because post-retirement taxes increase as income levels increase, Aon says. For example, post-retirement taxes increase from 0.7% of post-retirement income for a $60,000 person to 9.3% for a $90,000 person. Thus, to pay the additional taxes, higher paid employees need more retirement income.
A copy of the full report is available at http://www.aon.com/about/publications/pdf/issues/rs_2004_06_replacement_ratio_study_674.pdf .
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