James Russell, Portland State University
According to the Organisation for Economic Cooperation and Development’s influential Pensions at a Glance, the United States has a gross retirement income replacement rate for average-income workers of 70.3 percent (see table 5.3). On the face of it, a 70.3 percent replacement rate is impressive. It matches the 70 percent replacement rate that most financial advisors consider to be the goal of retirement planning strategies. That will surprise those who believe there is a growing retirement crisis in this country. Given the prestige of the OECD, it would seem to be prima face evidence that the retirement crisis is a myth.
But is that statistic valid? Will typical workers receive 70.3 percent of their preretirement income when they leave work?
The 70.3 percent figure is for Social Security plus employer-sponsored plans. For Social Security, it is 39.4 percent for an average worker (higher for a low-paid worker, and lower for the better-paid)—rates that are modest by international standards.[i] For employer-sponsored plans, it is 30.9 percent at all earnings levels.
However, a close reading of OECD’s methodology and country profile section for the United States reveals that the 70.3 percent replacement rate is an outcome under ideal rather than typical conditions. For this table, the OECD did not study actual outcomes of national retirement systems but rather their plan designs. What are being compared are not real worker experiences. Instead, they are those of hypothetical workers who work full time from age 22 to 66, have an average salary for their entire careers, and, in the case of the United States, save a steady 9 percent of salary year in and year out through defined contribution plans.[ii]
The model assumption of contributing to a retirement plan for an entire career is more reasonable for the Social Security portion because it is a national plan that covers 94 percent of the workforce. But, few workers belong to employer-sponsored defined-contribution retirement plans for 44 years. Fewer still have plans that provide combined employer-employee 9 percent of salary contributions.
The assumption that typical workers will have average salaries all of their work lives is also problematic. Few workers begin their careers with average salaries. They work their way up to them. That assumption affects both the Social Security and employer-sponsored replacement rate estimates. It also greatly exaggerates workers’ ability to save large sums toward retirement early in their careers.
We can safely conclude that the actual replacement rate for typical workers is much lower, especially considering that close to half at any given time do not have employer-sponsored retirement plans.
If the OECD wants to keep publishing that table, it should, at the very least, explain in a prominent footnote that it bases replacement rate estimates on models of ideal rather than typical circumstances.
UPDATE: A draft of this note was sent to the OECD for comment. Hervé Bouhol, head of its pension team, agreed with its substance. He acknowledged that the replacement rates were best cases and not meant to be representative. But because those assumptions and limitations were explained elsewhere in the publication he disputedthat the table was misleading. The author urged that the assumptions be included with the table to avoid the numbers being reported as is without the necessary caveats. Mr. Bouhol agreed, stating that this would be done “for the new issue next year if formatting issues allow.”
James W. Russell
Department of Political Science
Portland State University
I am indebted to Kathy Ruffing for her astute comments.
[i] Center on Budget and Policy Priorities, Policy Basics: Top Ten Facts about Social Security.
Thanks, Jim, for throwing the spotlight on this important topic! OECD assumes everyone saves a large fraction of pay starting in their early 20s and continuing for more than 4 decades. But actual outcomes in the U.S. look very little like that assumption: only half of new retirees have 401(k) or other retirement savings accounts, and balances are modest except for a lucky few. See https://www.cbpp.org/blog/for-most-americans-retirement-accounts-are-paltry. OECD paints an unjustifiably rosy picture of retirement in the U.S.