New Retirement Income Model Shows Which Workers Are at Highest Risk

A detailed new retirement readiness model created by researchers at Morningstar confirms that defined contribution plan access provides a big boost to retirement readiness for a given individual, but the work also lays bare some major gaps in readiness among certain demographic groups.

Specifically, lower-income workers are at a considerably higher risk of retirement insecurity — especially if the funding woes of Social Security aren’t addressed — as are baby boomers and members of Generation X who face shorter accumulation periods in workplace retirement plan savings.

The findings from the new “stochastic decumulation module” are detailed in a white paper put together by Spencer Look, an associate director of retirement studies, and Jack VanDerhei, director of retirement studies.

Look and VanDerhei suggest that the new model offers an improved understanding of U.S. retirement readiness thanks to its explicit breakdown of many important post-retirement considerations, such as longevity risk, investment risk and the risk of catastrophically expensive long-term services and supports.

Simpler models remain useful, the pair note, but they generally provide only limited visibility into the retirement readiness challenge by computing a replacement rate at retirement and then assuming that those above a certain threshold will have a successful retirement. The new model includes more realistic assessments of what can happen to people later in life.

Race and ethnicity also play a key role, the model shows, with Hispanic and Black Americans being more likely to experience shortfalls leading up to and during retirement. This derives largely from income inequality that affects these groups throughout their savings journey.

“This research highlights the vulnerability of certain demographics to retirement shortfalls and underscores the importance of defined-contribution plans in retirement preparedness,” Look and VanDerhei argue. “Policies should encourage access to and participation in employer-sponsored retirement plans, especially for younger and lower-income workers.”

Here are seven findings from the researchers’ modeling.

1. Older generations are at risk.

Even assuming that Social Security’s funding issues are solved, the model shows that baby boomers and Gen Xers are more likely to experience retirement shortfalls than other generations in the workforce.

“We focused our analysis on cases wherein the retirement-funded ratio was less than 1 (as these are, by definition, a shortfall),” the pair writes. “We found that baby boomers and Gen Xers are more likely to run short of money than those in other generations.”

In particular, Look and VanDerhei found that 47% of Gen Xers and 52% of baby boomers may experience retirement shortfalls, compared with 37% for Gen Z and 44% for millennials.

The results for baby boomers and Gen X are in a large part already determined by their current level of savings, the pair explain, as members of these generations do not have that much time left to save for retirement.

“Baby boomers and Gen Xers may have lower levels of retirement savings because they were impacted by the transition from a DB-dominant system to a DC-dominant system,” Look and VanDerhei write. “Even within these two generations there are discrepancies, as baby boomers were more likely to experience the early portion of the transition, when the understanding of how to use a DC plan was not as developed as it is now.”

Additionally, products such as target-date funds and managed accounts — as well as newer DC plan features, such as auto-enrollment and auto-escalation — are more recent developments that have helped later generations better use DC plans.

2. DC plan participants have better prospects.

The paper points to an ongoing debate about whether the United States faces a major retirement crisis. Look and VanDerhei say their model shows the answer is a qualified “yes.”

“There is a retirement crisis … for those who do not or are unable to participate in a defined contribution plan,” they write. “We found that retirement funding ratios were dramatically better for those who are simulated to participate in a DC plan for 10 or more years in the future.”

Specifically, Look and VanDerhei find that 57% of those not participating in a DC plan in the future may run short of money, compared with only 21% for those with 20 or more years of future participation in a DC plan.

“While participation is the most important factor in retirement adequacy, the industry should continue to move towards auto-portability, wherein an individual’s account with a former employer’s DC plan is automatically transferred to the individual’s account with a new employer-sponsored plan,” the pair writes.

Auto-portability will lead to smaller retirement shortfalls because it should reduce cash-out rates, Look and VanDerhei conclude.

3. Income level matters for retirement readiness.

Workers in the bottom two income quartiles are much more likely to run short of money in retirement, Look and VanDerhei report.

“Namely, over 80% of households in the first income quartile with [zero assumed] years of future participation in a DC plan are projected to run short of money in retirement,” the authors warn.

However, retirement deficits for this income quartile are notably lower in cases in which household members are simulated to participate in a DC plan for 10 or more years. For example, focusing on the lowest income quartile, only about 52% of the households experienced retirement shortfalls when participating in a DC plan for 20 or more years.

“This finding reinforces the point we made earlier that the retirement industry should focus on improving plan access and plan participation,” the authors suggest.

4. Racial and ethnic disparities remain.

As has been the case in prior analyses, Hispanic and Black Americans are found to be more likely to run short of money than Americans of other racial and ethnic backgrounds.

“Focusing on the results from a race and ethnicity perspective, we found that Hispanic and non-Hispanic Black Americans were much more likely to experience retirement shortfalls than Americans from different race and ethnicity backgrounds,” the authors note.

Specifically, some 61% of Hispanic Americans and 59% of non-Hispanic Black Americans are projected to have a retirement-funded ratio in the new model of less than 1.

The results for non-Hispanic white Americans and non-Hispanic other Americans (including Asian Americans) are significantly better, the authors find, with only about 40% of both groups experiencing retirement shortfalls

5. Single female households struggle more.

Overall, about 45% of Americans will experience retirement funding shortfalls, according to the model, but women who are single at retirement are more at risk than single men and couples.

Look and VanDerhei found that about 55% of single female households are projected to be at risk in retirement, compared with 41% for couples and 40% for single men.

As with the gaps on race and ethnicity, life-long income inequality is the main culprit here, but women also have to contend with greater projected longevity.

6. Workers in some industries are in better shape than others.

The analysis shows that retirement funding ratios vary substantially by industry, with public-sector workers appearing most prepared for retirement: Only about 29% of workers in this industry are projected to experience retirement shortfalls.

The public sector is followed by the finance, insurance and real estate industries, while lower readiness is measured across the services industry and the manufacturing industry.

7. Early retirees face more risk.

Only about 28% of U.S. households would experience shortfalls if retiring at 70, according to Look and VanDerhei, compared with 45% if retiring at 65.

“We conducted sensitivity testing to assess the impact of retiring earlier or later than our baseline retirement age of 65,” the authors explain. “Namely, we calculated retirement-funded ratios assuming a retirement age of 62, 65, 67 and 70. The results are intuitive, with retirement adequacy improving substantially at later retirement ages.”