Alternative Measures of Replacement Rates

Published: 2006
Project ID: UM06-03


Proposals to alter Social Security or Medicare benefits will need to take into account the economic resources and needs of the pre-retirement cohorts. Yet, the most widely used measure, the income replacement rate, is not an adequate guide to assessing economic preparation for retirement. For example, it does not take into account differing taxes prior to and following retirement, work-related expenses, nor financing consumption out of savings. This project will provide a generalization of an income replacement rate that recognizes a number of important differences between the pre- and post-retirement states. It will define combinations of post-retirement income, housing wealth and nonhousing wealth that will provide an adequate replacement for the loss of earnings associated with retirement. For example, it will account for the contribution that wealth can make to support consumption, rather than just the income from wealth, which is implicit in an income-based replacement rate. A major point of departure from prior studies is that this project will use data on actual spending, income, tax rates and wealth. These data have only recently become available in the Health and Retirement Study augmented with data from the Consumption and Activities Mail Survey. The methods will be applied to the pre-retirement population and to sub-populations such as the disabled and those in the lowest quintile of the income distribution because of the interest of policy makers in these low-income groups. This proposed project will provide a tool for a better assessment of the economic status of those nearing retirement than the standard replacement rate.