FDIC Outlook Are Baby Boomers Financially Prepared for Retirement?
After U.S. soldiers returned from World War II, fertility rates rose, resulting in 18 years of higher birth rates from 1946 through 1964the "baby boom" years. Seventy-six million babies were born in the United States during this time, 12 million more than the 64 million who would have been born during this period if fertility levels had remained at prewar levels. In 2006, these American baby boom children now range in age from 42 to 60.
Many baby boomers are nearing the traditional retirement age of 65. However, reduced availability of pensions with defined benefits, uncertainties related to retirement plans funded largely by employee contributions, and lower levels of savings have challenged financial planning for many baby boomers. This article explores the primary sources of baby boomer retirement income, discusses impediments to accumulating future savings, and identifies some situations that could unexpectedly change retirees financial situations.
Baby Boomers Are Aging, as Is America
Advances in medicine have increased longevity, resulting in an older America. The percentage of the population that is older has grown during the past century. The number of Americans 65 and older rose 183 percent between 1950 and 2000, more than double the 77 percent increase in the number of Americans under 65. This rapid growth in the elderly population increased the share of the population age 65 and older from 8.2 percent to 12.4 percent. Some of this growth can be attributed to the significant increase in life expectancy that occurred during the 20th century. At age 65, women today are expected to live 25 percent longer than their counterparts in 1960, while men are expected to live 31 percent longer.1 In addition to medical advancements lengthening life spans, the large number of baby boomers approaching 65 will continue to swell that age group.
Declining fertility rates also are contributing to this demographic shift, shrinking the size of subsequent generations. Although fertility rates were lower among baby boomers than among preceding generations, the size of this age demographic meant more parents were having children. Between 1977 and 1995, 72 million babies were born, approximating the 76 million babies born during the baby boom. Nevertheless, the trend of an aging U.S. population is projected to continue through the first half of the 21st century (see Chart 1). Large numbers of baby boomers are now nearing retirement age.
Will Baby Boomers Have Sufficient Income in Retirement?
Baby boomers work-related retirement income consists largely of Social Security
and pension income. As of July 2005, more than 30 million retired workers were
receiving Social Security income, with benefits averaging $960 per month, or
less than $12,000 per year.2 Although the Social
Security program is designed only as a supplement to other sources of income,
during 2003 the majority of senior Americans relied on Social Security as the
source for at least 80 percent of their income (see Chart 2).
Retirement Income: A Mix of Pensions and Social Security
For retirees to maintain a standard of living reasonably close to what they had while working, employment-related pension income is needed to supplement Social Security. Two basic types of pension plans existdefined benefit plans and defined contribution plans.3 Defined benefit plans are traditional employer-funded pension plans that provide a fixed income stream during retirement. In defined contribution plans, the employee makes retirement contributions that may be matched at least in part by the employer.4
The distribution of pension plans has changed sig nificantly during the past 25 years (see Table 1). In 2003 and 2004, only 17 percent of workers were covered by defined benefit plans, compared with 41 percent in 1978. Fully 25 percent of workers were not covered under either defined benefit or defined contribution plans.
Savings Have Shifted from Defined Benefit to Defined Contribution
Plans over the Past 25 Years
Benefit Plan Participation
Number (in millions)
Contribution Plan Participation1
Number (in millions)
is measured by the number and percentage of private, nonfarm, wage
and salary workers participating in the given plan.
The IRS did not issue 401(k) regulations until 1981. One earlier type
of defined contribution plan is the employee stock ownership plan,
which invests primarily in stock of the employer.
Source: Employee Benefit Research Institute.
Defined Benefit Plans and Defined Contribution Plans Have Limitations
Fewer workers are now covered by defined pension plans, and those with coverage may find that the plans have shortcomings. The plans are often less generous than in the past and rarely adjust for inflation. In addition, workers are changing jobs more frequently, and defined benefit plans lack of portability is a major issue for participants (see "The Shift Away from Defined Benefit Plans," page 10, for more information on defined benefit and defined contribution plans).5
Defined contribution plans offer the opportunity for workers to accumulate wealth during their working years. Employee salary contributions, in many cases coupled with some matching employer contributions, provide funds for employees to invest throughout their careers. Employees have the potential to accumulate large sums in these savings plans. The outcome depends on (1) employees beginning to contribute early in their careers and regularly contributing the maximum allowable amounts, (2) funds being invested wisely, and (3)employers matching contributions. However, based on a review of outstanding 401(k) balances, it does not appear that the average baby boomer has accumulated substantial wealth in their retirement accounts (see Table 2). For baby boomers who were in their 40s and 50s in 2003 and had 401(k) plans, the maximum average 401(k) accumulation was less than $140,000, and many had considerably less.6
Balances Generally Increase the Longer Participants Work but Still
May Not Fully Fund Retirement
401(k) Account Balance in 2003 (by participant job tenure)
Investment Company Institute. 2005. The Investment Company Factbook
(tabulations from EBRI/ICI Participant-Directed Retirement Plan Data
In addition to having less-than-desired wealth accumulation in 401(k) plans, some participants compound that problem by borrowing from their plans while working and sometimes having loans outstanding when they retire. In 2003, 18 percent of eligible 401(k) plan participants borrowed from their account and had average loan balances of 13 percent of their account balances.7
Perhaps a more important issue is that employees generally direct the investment decisions and bear the resulting investment risk for defined contribution plans. Further, investment returns for defined contribution plans are not guaranteed and can be greatly affected by market fluctuations. This uncertainty can make retirement planning more challenging. Finally, since defined contribution plans are voluntary, fully 18 percent of employees do not participate at all.8 These factors tend to reduce the effectiveness of defined contribution plans in providing adequate funding for retirement.
Baby Boomer Assets May Not Adequately Supplement Retirement Income
While there is no definitive standard for how much a person needs for retirement, many baby boomers appear to have a net worth insufficient to meet basic retirement needs, according to some guidelines.9 In 2004, the median net worth for families headed by baby boomers between the ages of 45 and 54 was $144,700.10 However, these data are somewhat difficult to interpret, as wealth holdings in the United States are skewed toward the top 10 percent of families (see Chart 3, next page). The median family net worth was $1,700 for the lowest 25 percent of U.S. households and $43,600 for those in the 25th to 49th percentile. In contrast, those in the 75th to 89th percentile had median family net worth of $506,800, while the figure for those in the top 10 percent was $1.4 million. These data do not apply only to baby boomers, however. Chart 3 suggests that although many families have a fairly substantial amount of assets, a large number have few resources with which to supplement retirement income.
The single largest source of wealth for retirees is often an illiquid asset, real estate.11 It is useful, therefore, to look separately at non-real-estate assets for a realistic picture of available assets retirees have accumulated. Although 94 percent of families headed by persons ages 45 to 54 held at least one type of non-real-estate financial asset in 2004, the median holdings of financial assets for this group were only $38,600.12 These data include 58 percent of families that held a median of $55,500 in retirement accounts (which include individual retirement accounts or IRAs), but only 18 percent that held the next largest asset category, pooled investment funds ($50,000). Even fewerless than 7 percentheld the third and fourth largest asset categories, other managed assets and bonds ($43,000 and $30,000, respectively) (see Table 3, next page).13 For the average person, financial assets would not last long in retirement.
Held by Families Headed by Baby Boomers Vary Widely
Holding Assets (percent)
Asset Value for Families Holding Assets (in 2004 dollars)
of Financial Asset
Value of Life Insurance
Heads of households are between 45 and 54 years old. Asset values
do not account for the present value of future Social Security benefits.
Source: Federal Reserve Board, 2004 Survey of Consumer Finances.
Inheritance is often considered another option to fund retirement. However, relatively few people will be able to rely on this strategy, or even substantially supplement their wealth through inheritance. For example, in 2003 only 66,000 estate tax returns were filed (estates of $1 million or more), compared with about 2.4 million deaths that year.14 Without substantial inherited wealth and in view of the difficulties related to providing sufficient retirement income, personal savings will often be needed to supplement Social Security benefits and pensions related to employment. However, several factors may constrain the ability of lower-income baby boomers to accrue assets to fund their retirements: uneven growth in incomes, significant levels of debt, and high current expenses.
The data presented thus far highlight the need for many baby boomers to increase savings for retirement aggressively. However, those with lower incomes may find this particularly challenging, in part because earnings growth has been skewed toward the highest-income households (see Table 4, next page).
Growth Was Greatest for Households with the Highest Earnings
Household Income (2004 Dollars)
U.S. Census Bureau (Historical Income Tables).
Heavy debt burdens can make wealth accumulation more difficult, because funds used to repay debt cannot be put into savings. By various measures, household debt has risen significantly. For example, household debt outstanding has been increasing steadily as a percentage of disposable personal income, from 70 percent in 1980 to 122 percent as of third quarter 2005.15 Further, the proportion of families with very large debt payments relative to income is also rising. In 2004, 13.1 percent of families headed by persons ages 45 to 54 had a debt-to-income ratio greater then 40 percent, an increase of 1.5 percentage points since 2001. This compares with 12.2 percent of all families with a debt ratio above 40 percent, only a 0.4 percentage increase since 2001.16
Another potential barrier to building additional retirement assets is that many older baby boomers have expenses somewhat unique to their age group. As baby boomers approach retirement age, they often become part of what has been called the "sandwich generation." At this point in their lives, boomers may still be caring for their children and providing for their educational needs while simultaneously facing financial burdens imposed by the health care costs of their aging parents.
On the positive side, data suggest that baby boomers have become more diligent in their efforts to save for retirement. Between 1995 and 2005, the percentage of workers who have saved for retirement has increased for each age category (see Table 5).
the Past Decade, More Workers from Each Age Group Have Saved for Retirement
Financial Planning Is Becoming More Complex for Aging Baby Boomers
As noted previously, many baby boomers have limited resources to fund their retirement and may find it difficult to add to their wealth. To help overcome these obstacles, it is important for baby boomers to be knowledgeable about their finances and actively plan their own financial futures or seek the assistance of financial professionals. The results of a recent survey focusing on baby boomer preparation for retirement suggest this is not the case among many older Americans; in fact, only 19 percent had engaged in successful retirement planning (defined as always or mostly able to stick to their plan).17 This is notable in light of the investment responsibilities that defined contribution plans place on the individual. For example, a frequently cited concern is that employees often hold too much stock in the company they work for in their 401(k) plans, failing to take advantage of the benefits of a more diversified portfolio. In 2003, 36 percent of workers in their 50s had more than 30 percent of their 401(k) account balances invested in their company stock, and 11 percent had more than 90 percent.18 The results of a financial literacy questionnaire may help explain why this occurs: Only 52 percent of the respondents understood correctly that holding a single company stock offers a riskier return than a stock mutual fund.19 So, while not all baby boomers need professional advice, it appears that many could benefit from greater assistance in their financial preparation for retirement.
Even with Careful Planning, Savings May Still Be Insufficient
Baby boomers who appear to be financially prepared for a comfortable retirement may continue to encounter unexpected challenges. Three areas of risk could complicate even the most carefully designed retirement plans: inflation risk, longevity risk, and risk of under estimated and unexpected expenses.
Risk of Inflation
Increases in consumer prices and the risk of inflation have been limited for a number of years, making it easy to forget that not long ago rapidly rising prices were a serious problem in the United States. Although the annual rate of increase in consumer prices, as measured by the consumer price index, has been 3 percent or less since 1992, this index rose at an annual rate of at least 10 percent in every year between 1979 and 1981.20 Rising prices can deplete the value of a fixed pension benefit and fixed-income investments, and therefore remain an ongoing risk for retirees.
Risk of Longevity
Baby boomers need to factor increased longevity into their financial planning. While advances in medicine are increasing average longevity, it remains difficult to predict accurately the length of the retirement period and, therefore, how long accumulated wealth must last. When uncertain longevity is com bined with the risk of inflation, it becomes problematic for even the most experienced planners to prepare for all scenarios.
Risk of Underestimated Health Care Expenses
Finally, underestimated and unexpected health care expenses could consume a large portion of retirement savings. For example, in March 2005, Fidelity
Investments estimated that the average 65-year-old couple retiring then would need $190,000 to cover medical costs during the next 15 to 20 years.21 This figure does not compare favorably with the 2004 median family net worth of $144,700 for the baby boomers ages 45 to 54. In addition, although the estimated cost of health care is a substantial figure, it is just an average, meaning that many people may need to spend considerably more. Moreover, this average health cost figure covers a 65-year-old retiree only through ages 80 to 85.
Is the Future Really So Dark?
This article has explored the question of whether baby boomers are financially prepared for retirement. Data on defined benefit plans, defined contribution plans, and wealth accumulation suggest that many baby boomers may not have adequate resources for a comfortable retirement. Moreover, issues such as uneven growth in incomes, large amounts of baby boomer debt, and high current expenses could make it difficult for baby boomers to increase their savings. Even those who appear financially well prepared for retirement face risks related to inflation, longevity, and health care costs.
However, the financial situation for many baby boomers is not as dire as it may seem. Changing preferences may lead baby boomers to seek a different type of retirement than their parents. For example, baby boomers may choose to postpone their retirement or begin a second career after retirement. Both scenarios would provide an opportunity for them to accumulate additional assets. The labor force participation rate for people ages 65 and older is 20 percent higher in 2005 than it was 25 years ago. Although the bulk of this increase is due to more elderly women participating in the labor force (the labor force participation rate for women ages 65 and older increased 43 percent during this period), participation for men in this age group is on the rise as well.22 Overall, although the financial future for many baby boomers is uncertain, continuing to work later in life may allay financial strains for some.
As longevity continues to rise with the development of new medical technologies, people who are able to work into their late 60s or 70s could become the norm. Life expectancy for people born today is 78 years, approximately ten more years than for people born during the baby boom generation. Should individuals choose to work for a portion or all of this time, this could help mitigate concerns about how prepared they are for retirement.
J. Aislinn Bohren, Economic Research Assistant
Heather Gratton, Senior Financial Analyst
Brian Lamm, Senior Financial Analyst
1 U.S. Department of Health and Human Services. 2005. Health,
United States, 2005, Table 27, Life Expectancy at birth, at 65 years of age, and at 75 years of age, according to race and sex: United States, selected years 19002003, p. 167.
3 Most defined contribution plans are 401(k) plans. Other defined contribution plans include 403(b) plans (offered by tax-exempt organizations such as churches, schools, and charities), employee stock ownership plans, and profit-sharing plans.
4 In defined contribution plans, the employee is responsible for the investment decisions and assumes the market risks. Defined contribution plans became increasingly popular when the stock market soared in the 1980s and 1990s. Over time, new companies, as well as many older ones, began offering only defined contribution plans, which take the burden of the investment and annuity risk away from the employer.
5 Some defined benefit plans have failed, and others are in financial trouble. Although the vested benefits of failed plans are insured by the federal Pension Benefit Guaranty Corporation (PBGC), there is a maximum insurance benefit. In 2005, the maximum insurance benefit for participants in terminating, underfunded pension plans was $45,614 per year for those who retire at age 65; the amount was higher for those who retire later and lower for those who retire earlier or elect survivor benefits. As a result, the pensions of some higher-income workers may be less than they anticipated or could change should the parent company experience financial difficulties. Some well-known pension failures covered by the PBGC include Kaiser Aluminum,
Bethlehem Steel, Polaroid, US Airways, and United Airlines.
6 U.S. Department of Labor, Employee Benefits Security Administration. July 2005. Preliminary
Private Pension Plan Bulletin, Abstract of 2000 Form 5500 Annual Reports (tables D3 and A1). In 2000, 401(k) assets totaled $1.725 trillion, which is 78 percent of the $2.216 trillion in total defined contribution assets.
8 Ruth Helman, Dallas Salisbury, Variny Paladino, and Craig Copeland. April 2005. "Encouraging Workers to Save: The 2005 Retirement Confidence Survey," EBRI Issue Brief No. 280. www.ebri.org. This survey suggests that 18 percent of employees do not participate in their workplace retirement savings plan. Nearly seven out of ten employees not using the plans are aware of them but simply choose not to participate.
9 One research report (Kenn B. Tacchino and Cynthia Saltzman, March 2001, "Should Social Security Be Included When Projecting Retirement Income?" Journal
of Financial Planning, table 1) suggested targets for asset accumulation by ages 66 to 67, after taking into account projected Social Security income, that ranged from $226,000 for those whose current income is $40,000 to $1.9 million for those whose current income is $200,000. Another rough rule of thumb suggested for asset accumulation for retirement recommended private savings of 12 to 16 times final salary (Ben Stein and Phil DeMuth, 2005, Yes,
You Can Still Retire Comfortably, Carlsbad, Calif.: New Beginnings Press). For example, using the lower-end multiple of 12, someone with an income of $50,000 would need at least $600,000 in assets to fund retirement.
10 Federal Reserve Board. March 2006. 2004 Survey
of Consumer Finances. The Survey of Consumer Finances is a triennial survey. In 2004, the 40 million baby boomers born between 1950 and 1959 fell into the 45 to 54 age bracket. The net worth data do not account for the present value of future Social Security benefits.
11 As noted previously in this article, for families headed by persons ages 45 to 54, in 2004 the median family net worth was $144,700, and 77 percent of these families owned a primary residence. The median home market value for these homeowners was $170,000. (Note: The home market value reflects gross value, which may differ significantly from the net equity in the home; figures on average home equity were not available.) Data from Federal Reserve Board 2004 Survey
of Consumer Finances.
12 See note 10.
14 Estate data are from the Internal Revenue Service. There were 2.4million deaths in 2002, per the National Center for Health Statistics of the Centers for Disease Control and Prevention (CDC) (www.cdc.gov/nchs/fastats/deaths.htm), and preliminary figures also show 2.4 million deaths for 2003 (see CDC, 2004, "Deaths: Preliminary Data for 2003," National
Vital Statistics Reports 53, no. 15).
15 Calculated using data from the Bureau of Economic Analysis and the Federal Reserve Board Flow of Funds.
18 Sarah Holden and Jack VanDerhei. August 2004. Perspective. Investment Company Institute. Statistics calculated from data contained in figure 6, "Asset Allocation Distribution of Participant Account Balances to Company Stock in 401(k) Plans with Company Stock by Age, 2003."