Post Retirement Replacement Income Falls over Time

August 7, 2012 ( – An analysis from the Social Security Administration (SSA) shows how income replacement in retirement decreases over time.

Using data from the Health and Retirement Study (HRS) for three different age cohorts who retired in three different waves, the analysis found the median replacement ratio for total income in the first or second year of retirement was 0.733 (or 73%). One-fourth of households had replacement ratios of 1.013 (101%) or higher and one-fourth had replacement ratios of 0.480 (48%) or less.   

The study shows replacement ratios fell over time, especially during the first seven to eight years of retirement. The median replacement ratio fell to 0.635 in the third or fourth year of retirement, to 0.599 in the fifth or sixth year, and to 0.555 in the seventh or eighth year.   

Study author Patrick Purcell, with the Division of Policy Evaluation, Office of Research, Evaluation, and Statistics, Office of Retirement and Disability Policy at the SSA, said the sharp decline from 0.733 to 0.555 over the first four two-year intervals of retirement may reflect conditions that are more likely to occur in the earlier years of retirement than in later years. Such conditions could include receipt of lump-sum pension settlements upon retirement, working part-time or working more hours part-time in the first few years of retirement, and the timing of a spouse’s retirement relative to the respondent’s date of retirement. It is also possible that income from the last year of full-time employment is mistakenly attributed to income in the first wave of retirement in some cases, despite the methodological precaution mentioned earlier.  

Purcell notes that most of the median replacement ratios are lower than the minimum ratio of 70% that financial planners often recommend, but his analysis is based on pretax income. Replacement ratios calculated on after-tax income would be about 20% higher than ratios based on pretax income.

The analysis also found that income replacement ratios would increase if the retiree used 80% of the household's non-housing assets to purchase an immediate income annuity upon retirement. Because assets used to purchase annuities would no longer generate interest and dividends, the increase in income generated by using 80% of non-financial assets to buy an annuity was offset in part by a proportional reduction in interest and dividend income.   

If all of the households in the sample had used 80% of their non-housing assets to purchase income annuities, their median replacement ratios would have been about 15 to 17 percentage points higher, on average.  

In addition, using 80% of home equity and 80% of household non-housing assets to purchase immediate annuities would raise median replacement ratios over each of the first five waves of retirement to levels about 24 to 26 percentage points higher.  

The Social Security Bulletin is at