The National Retirement Risk Index (NRRI), developed by the Center for Retirement Research at Boston College, has provided a key metric for evaluating the retirement preparedness of American households. Recently, the NRRI reported a significant improvement in retirement readiness, dropping from 47 percent to 39 percent between 2019 and 2022. This promising development warrants a closer examination of the factors contributing to this decline and its implications for future retirees.
Factors Behind the Improvement
The period between 2019 and 2022 was marked by extraordinary economic and social upheaval, including the COVID-19 pandemic. Despite this, several factors combined to enhance the financial standing of many households:
- Government Stimulus and Strong Employment: The pandemic saw unprecedented fiscal support from the government. Stimulus payments and enhanced unemployment benefits helped many households stabilize their finances. Employment remained relatively robust, providing a steady income for a significant portion of the population.
- Soaring Home Values: The most influential factor in the NRRI’s improvement was the dramatic increase in home values. From 2019 to 2022, U.S. home prices rose by about 22 percent in real terms. This surge in property values bolstered household wealth, mainly for homeowners nearing retirement.
- Increased Savings Rates: The pandemic prompted a spike in personal savings rates, driven by reduced spending opportunities and government stimulus. Personal savings rates soared to over 30 percent of disposable income during the peak of the pandemic before returning to pre-pandemic levels.
- Stock Market Gains: Despite volatility, the stock market ended significantly higher in 2022 than in 2019. This increase in equity prices enhanced the retirement portfolios of many households, especially those in higher income brackets who hold a substantial share of market assets.
Analyzing the Nuts and Bolts of the NRRI
The NRRI measures the proportion of households at risk of being unable to maintain their pre-retirement standard of living. Constructing the NRRI involves three key steps:
- Projecting Household Replacement Rates: This step estimates the retirement income for households at different retirement ages (62 for low income, 66 for middle income, and 67 for high income). It includes income from Social Security inflation, defined benefit (DB) plans, defined contribution (DC) plans, and housing equity.
- Estimating Target Replacement Rates: These are calculated using a consumption-smoothing model, which aims to maintain the same level of consumption in retirement as before retirement. Factors such as reduced taxes and no longer needing to save for retirement are considered.
- Comparing Projected and Target Rates: Households whose projected replacement rates fall more than 10 percent below their target are deemed at risk. The NRRI is the percentage of households falling short of their target.
Implications and Future Considerations
While the drop in the NRRI to 39 percent is encouraging, it is essential to consider whether this improvement will persist. The significant factors contributing to the decline, such as soaring home values and pandemic-induced savings, may not be sustainable. Housing prices are subject to market fluctuations, and the high levels observed recently may not continue. Additionally, the unique savings patterns seen during the pandemic are unlikely to be repeated.
Moreover, most households do not typically tap into their home equity through reverse mortgages, a fundamental assumption in the NRRI calculations. If housing equity is excluded, the percentage of households at risk would be significantly higher. Studies indicate that without considering home equity, about 70 percent of households might fall short of maintaining their pre-retirement standard of living.
Conclusion
The substantial drop in the NRRI from 47 percent to 39 percent between 2019 and 2022 reflects an improvement in retirement preparedness driven by several unique factors. However, the reliance on temporary boosts such as elevated home prices and pandemic-induced savings raises concerns about the sustainability of this improvement. It underscores the need for a robust retirement system, ensuring that Social Security remains financially sound and that employer plan coverage is universal. While the immediate outlook appears brighter, long-term strategies are essential to secure the retirement readiness of future generations.
