One of the basic objectives of EBRI’s Retirement Security Projection Model® (RSPM) is to simulate the percentage of the population that will be “at risk” of having retirement income that is inadequate to cover basic expenses and pay for uninsured health care costs for the remainder of their lives once they retire.[i] However, the EBRI Retirement Readiness Rating™ also provides information on the distribution of the likely number of years before those at risk “run short of money,” as well as the percentage of compensation they would need in terms of additional savings to have a 50, 70, or 90 percent probability of retirement income adequacy.
VanDerhei and Copeland (July 2010) describes how households (whose heads were ages 36–62 in 2010) are tracked through retirement age, and how their retirement income/wealth is simulated for the following components:
- Social Security.
- Defined contribution balances.
- IRA balances.
- Defined benefit annuities and/or lump-sum distributions.
- Net housing equity.
A household is considered to run short of money in this model if aggregate resources in retirement are not sufficient to meet aggregate minimum retirement expenditures, defined as a combination of deterministic expenses from the Consumer Expenditure Survey (as a function of income), and some health insurance and out-of-pocket health-related expenses, plus stochastic expenses from nursing home and home health care (at least until the point such expenses are picked up by Medicaid). This version of the model is constructed to simulate “basic” retirement income adequacy; however, alternative versions of the model allow similar analysis for replacement rates, standard-of-living calculations, and other ad hoc thresholds.
The baseline version of the model used for this analysis assumes all workers retire at age 65 and immediately begin to withdraw money from their individual accounts (defined contribution and cash balance plans, as well as IRAs) whenever the sum of their basic expenses and uninsured medical expenses exceed the after-tax[ii] annual income from Social Security and defined benefit plans (if any). If there is sufficient money to pay expenses without tapping into the tax-qualified individual accounts,[iii] the excess is assumed to be invested in a non-tax-advantaged account where the investment income is taxed as ordinary income.[iv] The individual accounts are tracked until the point at which they are depleted. At that point, any net housing equity is assumed to be added to retirement savings in the form of a lump-sum distribution (not a reverse annuity mortgage). If all the retirement savings are exhausted and if the Social Security and defined benefit payments are not sufficient to pay basic expenses, the entity is designated as having “run short of money” at that time.
[i] The nominal cost of these expenditures increases with component-specific inflation assumptions. See the appendix for more details.
[ii]IRS tax tables from 2011 are used to compute the tax owed on the amounts received from defined benefit plans and Social Security (with the percentage of Social Security benefits subject to federal income tax proxied as a function of the various retirement income components) as well as the individual account withdrawals.
[iii] Roth IRA and 401(k) accounts are not used in this version of the model but will be incorporated into a forthcoming EBRI publication.
[iv]Capital gains treatment is not used in this version of the model.