Retirement Security: Better Information on Income Replacement Rates Needed to Help Workers Plan for Retirement
Released: 2016-03-01T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: Part of DOL's mission is to promote the retirement security of America's workers, a goal that has become increasingly challenging. One tool for assessing the adequacy of retirement income is the replacement rate. However, recommendations for the replacement rate that a household should target vary widely, in part because of the diverse underlying assumptions used to develop the rates. GAO was asked to review what consumption in retirement looks like and how target replacement rates are developed.

GAO examined (1) whether and how spending patterns vary by age, (2) key factors used to develop target replacement rates, and (3) the usefulness of information on such rates provided by DOL. GAO analyzed data from the BLS's 2013 Consumer Expenditure Survey, the most recent available; analyzed 59 articles and reports that discussed how to develop, calculate, or evaluate replacement rates; collected non-generalizable information from 14 retirement services firms and financial planners recommended by researchers and actuaries who have studied replacement rates; and reviewed DOL materials and interviewed officials.

section_title: What GAO Found
paragraphs: Household spending patterns varied by age, with mid-career households (those aged 45-49) spending more than older households. For example, according to 2013 survey data from the Bureau of Labor Statistics (BLS), mid-career households spent an estimated average of around $58,500, while young retiree households (those aged 65-69) spent about 20 percent less. While the share of spending was consistent for some categories, other categories had larger variations across age groups. For example, housing expenses comprised the largest share of spending regardless of age, while older households spent more out of pocket on health care than mid-career households. Spending was less variable across age for low-income households compared to other households. For example, there was not a significant difference in average spending between mid-career and young retiree households in the lowest income quartile, compared to an approximately $20,000 difference for the highest income quartile. These variations in spending patterns have implications for the resources households need to maintain their standard of living in retirement.

Researchers and financial industry professionals develop target replacement rates—the percentage of income to aim for in retirement— based on certain key factors, including spending, household characteristics, and pre-retirement earnings. GAO's analysis of the literature found that calculating an appropriate replacement rate can be complex. For example, there is debate over whether households that have raised children should target a lower replacement rate than households that have not. In addition, a worker's pre-retirement earnings could be defined as earnings at the end of the worker's career or as average earnings over the course of the career. Despite these complicated considerations, target replacement rates cited in the articles and reports GAO reviewed typically range between 70 and 85 percent. Some financial industry professionals told GAO that they develop customized targets that take into account workers' assets and expected spending, while others questioned the usefulness of replacement rates.

The information and tools on replacement rates that the Department of Labor (DOL) provides may be too limited to help workers understand how to use such rates for retirement planning. DOL's Employee Benefits Security Administration's (EBSA) website provides information and tools to help American workers better plan for retirement, including a tool to help workers calculate their retirement income needs as a percentage of preretirement income. While EBSA's materials note that a target replacement rate can vary based on individual circumstances, they do not include specific examples of demographic groups that research indicates can result in higher or lower income replacement needs, or how much a replacement rate might need to be adjusted for those groups or for other individual circumstances. Without additional information, workers may not understand how to adjust target replacement rates when planning for retirement. Further, EBSA's worksheet and online tool for calculating how much to save use a default replacement rate with no opportunity for a user to adjust the rate based on individual circumstances. Without the ability to adjust the replacement rates used in planning tools, workers may over- or under-estimate how much they need to save for retirement.

section_title: What GAO Recommends
paragraphs: GAO recommends that DOL provide additional examples and guidance on using a replacement rate for estimating retirement savings needs in its planning tools, and modify the planning tools so the rate can be adjusted. DOL generally agreed with our recommendations and plans to add information and provide options for adjusting replacement rates in its planning tools by June 2017.

section_title: Letter
paragraphs: Whether older Americans will have adequate income in retirement has  been a longstanding concern for several reasons including the decline in  defined benefit pensions, the growing responsibility for individuals to save  for retirement through employer-sponsored defined contribution plans or  on their own, and the financial challenges facing Social Security. To  better predict how much income Americans will need once they leave the  workforce, many researchers use target replacement rates—the  percentage of pre-retirement income needed to maintain a certain  standard of living in retirement. In recent years, numerous studies on the  replacement rates that households should target have not resulted in a  consensus recommendation, in part because estimates are heavily  dependent on the underlying assumptions used to develop them. To  accurately interpret the implications for retirement adequacy it is  important for policy makers and individuals to better understand how  these targets are developed.

You asked us to review what consumption looks like in retirement and  how replacement rates are defined, calculated, and used to assess  retirement preparedness. This report assesses (1) whether and how  spending patterns vary by age, (2) key factors used to develop target  replacement rates, and (3) the usefulness of information on retirement  replacement rates provided to workers by the Department of Labor.

To assess whether spending patterns vary across working and retired  households, we used 2013 expenditure data from the Bureau of Labor  Statistics’ Consumer Expenditure Survey (CE). This was the most  recently available data at the time of our review. The CE is a sample  survey designed to be representative of the total U.S. noninstitutionalized  civilian population and is used to collect data on consumers’  characteristics and buying habits. We conducted a cross-sectional  analysis to see how spending patterns vary across different age groups.  We also conducted a regression analysis to understand how the effects of  age vary by spending category, such as health care and housing, and  household income level. To ensure the variables we analyzed in the 2013  CE data were reliable for our purposes, we reviewed survey  documentation, compared results to published tables, and interviewed  agency officials. Based on this, we found the data to be reliable for the  purposes used in this report.

To understand the various factors considered when developing a target  replacement rate, we conducted a literature search from January 2015  through January 2016, which generated a total of 630 results. We  reviewed abstracts, when available, to identify which articles (1)  contained information on target replacement rates or assumptions  needed to calculate a replacement rate and (2) were published in or after  2005 in academic journals or by research centers or international  organizations. We determined 59 articles and reports met these criteria  and included them in our analysis. In addition, we used a questionnaire— coupled with interviews—to assess whether financial firms use target  replacement rates and, if they do, what factors financial industry  professionals considered when developing these targets. To determine  which firms to contact, we relied on suggestions from several researchers  and actuaries who have studied replacement rates. In total, we collected  information from 14 firms—7 service providers, 3 retirement services  consulting firms, and 4 financial planners. While these firms provided  valuable insight into target replacement rate recommendations, our  findings are not generalizable to the full population of service providers,  retirement consulting firms, and financial planners. To identify the range  of target replacement rates recommended to U.S. workers, we  catalogued references to such recommendations in the studies we  selected for review. Our analysis focused on total replacement rates—the  ratio of all income in retirement (including Social Security, pension  benefits, and retirement savings) to pre-retirement earnings. We sought  to identify a number of considerations that researchers, policy makers,  and financial professionals incorporate into their assumptions when  developing, calculating, or evaluating target replacement rates. However,  because analyzing the merits and disadvantages of each consideration  was outside the scope of our work, we are not endorsing any of the  considerations presented in this report.

To assess the usefulness of the information on replacement rates  provided to workers by the Department of Labor (DOL), we reviewed  relevant retirement planning materials produced by the agency and we  interviewed agency officials. Lastly, we reviewed relevant federal laws  and regulations. Although we found references to replacement rates in  Social Security Administration (SSA) and Consumer Financial Protection  Bureau documents, we focused our review on DOL materials as DOL is  required by law to provide a means of calculating retirement savings  needs using a replacement rate. For more information on our objectives,  scope, and methodology, please see appendix I and the bibliography at  the end of this report.

We conducted this performance audit from January 2015 to March 2016  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Some key sources of retirement income are Social Security benefits,  defined benefit plans, defined contribution plans, Individual Retirement  Accounts (IRAs), as well as personal savings. In recent years,  employment-based retirement plan coverage, especially in the private  sector, has shifted from defined benefit to defined contribution plans.  Under “traditional” defined benefit plans, workers typically receive  benefits—based on factors such as salary and years of service—in the  form of a lifetime annuity that provides a guaranteed monthly payment.  Defined benefit plans are, in most cases, financed by employers, who are  responsible for managing plan assets. Defined contribution plans and  IRAs are two primary types of retirement savings vehicles in which  benefits accrue in the form of account balances, which grow from  contributions made by workers (and sometimes by their employers) and  investment returns. Workers and employers who contribute to retirement  savings accounts generally receive favorable federal tax treatment, such  as tax deductions for contributions and tax-deferred or even tax-free  returns on investment. In addition to tax advantages, defined contribution  plans and IRAs provide portability of savings and transparency of known  account balances. However, they also place the primary responsibility on  individuals to participate in, contribute to, and manage their accounts  throughout their working careers. Moreover, individuals must manage  their savings throughout retirement, including deciding whether and how  to convert an account balance into an income stream, in order to avoid  running out of money.

This shift in responsibility is further compounded by the low levels of  financial literacy in the United States. As we have previously reported,  numerous studies have found that many Americans lack basic financial  literacy, including an understanding of fundamental investment concepts,  such as the benefits of compounding interest and risk diversification and  the potential impact of inflation. We concluded that such basic financial  literacy is necessary for making well-informed decisions and evaluating  recommendations. Financial literacy research has also pointed to the  need to educate individuals to improve their investment decision-making  and savings outcomes. For example, one study found that a large  percentage of American workers has not conducted meaningful  retirement planning, even when retirement is in the near future. Another  study found that most workers acknowledge they do not know as much as  they should about retirement planning and that many workers actually  guessed at their retirement savings needs. Further, our past work has  found that ensuring income in retirement requires workers to make  difficult choices and that workers may not have sufficient information to  determine which choices are in their best interest.

Many studies have evaluated the retirement readiness of workers and the  economic well-being of retirees. These studies have used a variety of  benchmarks for assessing retirement readiness or well-being, including  assorted measures of retirement saving, income, consumption, wealth,  and standard of living. Economists broadly agree that a conceptual  benchmark measure for adequate retirement saving is an amount that  will, along with other sources of retirement income, allow a household to  maintain its pre-retirement standard of living into retirement. A key  concept underlying such a measure is the lifecycle model of savings,  which suggests that individuals will adjust their saving and spending to  ensure a consistent level of consumption over their lifetime.

Income replacement rates, measured as a percentage of pre-retirement  income, are one common method for analyzing the retirement readiness  of individuals and providing information to help individual workers plan for  retirement. Plan sponsors and researchers have long used them to  assess the adequacy of pension plan benefit levels. Replacement rates  can also show the extent to which individuals are able to replace their  pre-retirement earnings with other sources of income in retirement, such  as Social Security benefits, pension benefits, or retirement savings. While  there is no consensus about how much income is required to ensure a  stable standard of living, economists and financial planners generally  agree that many retirees do not need to replace 100 percent of their pre- retirement income to maintain their standard of living because most  retirees probably have reduced expenses relative to when they were  working. For example, spending on transportation may be reduced for  those who no longer need to commute to work. As a benchmark of how  much income will be needed in retirement, a target replacement rate can  help alert workers about how much to save as well as how long to work or  how much to spend. However, while a replacement rate provides an  individual with important information for developing a long-term savings  goal, it does not provide a plan for achieving it. Converting a target  replacement rate to a savings plan—such as how much to set aside from  each paycheck—over a number of years is a complicated exercise and  may prove daunting, especially in light of the limited financial literacy of  many Americans.

DOL is responsible for providing guidance on retirement income savings  for workers. The Employee Retirement Income Security Act of 1974, as  amended (ERISA), directs the Secretary of Labor to “maintain an ongoing  program of outreach to the public designed to effectively promote  retirement income savings by the public.” With regard to replacement  rates specifically, ERISA also directs the Secretary of Labor to establish a  website that includes a “means for individuals to calculate their estimated  retirement savings needs, based on their retirement income goal as a  percentage of their preretirement income.”

section_title: Mid-Career Households Spent More than Older Households, and Spending Patterns Varied by Expenditure and Income Level
subsections: section_title: Older Households Spent about 20 Percent Less than Mid-Career Households in 2013
paragraphs: Based on our analysis of 2013 CE data, mid-career households had one  of the highest spending levels, while older households generally spent  less. More specifically, in 2013, mid-career households—those aged 45- 49—spent an estimated average of about $58,500, while young retiree  households—those aged 65-69— spent about $46,800, or 20 percent  less overall (see fig. 1). We also analyzed spending across two broader  age groups: pre-retirement households (aged 50-64) and post-retirement  households (65-79) (see table 1). We found that the difference in  spending between broader age groups was similar to the comparison  between mid-career and young retiree households using 5-year age  groups. The estimated average total spending for post-retirement  households was about 77 percent of the spending levels for pre- retirement households.

Spending was lower among mid-retiree and older retiree households  compared to mid-career and young retiree households (see table 2). For  example, mid-retiree households (aged 75-79) spent an average of  around $34,700, or 26 percent less, than young retiree households.  Average spending for older retiree households (aged 80 and older) was  slightly less than mid-retiree households at around $31,400, although  differences were not statistically significant.

The patterns in total spending may, in part, reflect variations in average  household size and priorities. The average household size for mid-career  households was about 2.9 people as compared to about 2.1 people for  young retiree households. The average household size was  approximately 1.7 people for mid-retirees and 1.5 people for older  retirees. Patterns in spending may also be affected by the age  composition of other members of the household. Lower spending for older  households could also be indicative of different priorities. For example,  one large relative difference in spending was attributable to the personal  insurance and pensions category. Mid-career households may be more  concerned with contributions toward retirement resources than older  households who could already be retired. Moreover, we found that in  2013, age groups varied in how much they spent, including on basic  needs, such as food, and non-essential items, such as entertainment.  Such fluctuations in spending have implications for the resources  households will need to maintain their standard of living. More  specifically, spending levels are indicative of how households allocate  resources based in part on different needs and lifestyle preferences, and  are an important consideration when planning for retirement.

section_title: Housing Was the Top Expense Regardless of Age, and Older Households Spent More Out-of-Pocket on Health Care
paragraphs: While the share of spending was relatively consistent across age groups  in some categories, there were larger variations by age for other  categories. On average, housing was the largest spending category for all  age groups. For example, households aged 45 and older consistently  spent about a third of total expenditures on housing. More specifically,  young retiree households spent about 83 percent of the amount that mid- career households spent for housing, on average (see fig. 2). However,  the composition of homeowners varied widely by age group. For example,  the proportion of homeownership without a mortgage for young retiree  households was three times higher than for mid-career households.  Housing expenditures include expenses such as maintenance,  operations, and utility costs that can be incurred regardless of ownership  status.

In contrast to other spending categories, health care was a larger  expense for older households. For example, young retiree households  spent an average of around $4,900 on health care, compared to about  $3,500 for mid-career households. Older retiree households spent a  large share on health care—15 percent of total spending—which was  more than double the share that mid-career households spent on health  care.

The age at which expenditures peak also shows how spending patterns  varied. For example, the amount a household spends on apparel was  estimated to peak at age 42, which was significantly younger than for  entertainment, where the amount a household spends was estimated to  peak around age 52. Spending on items such as apparel and  transportation may be more relevant during a household’s working years.  Further, spending in some categories may increase with age as  households have more time or resources for certain expenses, such as  recreational activities.

section_title: Unlike for Other Households, Spending Was Relatively Flat Across Low-Income Households Regardless of Age
paragraphs: Spending levels across age groups were relatively similar for low-income  households, while spending levels were more variable for high-income  households (see fig. 3). More specifically, the difference in average total  spending for low-income households between the mid-career and young  retiree age groups was not statistically significant, while the difference  across these same age groups was over $20,000 for the highest income  quartile.

Though low-income households had much lower overall spending than  mid- or high-income levels, they spent a larger share on necessities like  housing and food, which could have implications for their respective  replacement rates. Low-income young retiree households had an average  of around $23,500 in out-of-pocket spending, with 39 percent spent on  housing and 19 percent on food. In comparison, high-income  households in the same age group spent about $82,200, of which 31  percent was spent on housing and 12 percent on food. While spending  levels provide information on consumption, expenditures do not  necessarily equate to a household’s level of consumption. For example, a  household could consume the same amount of food at different  expenditure levels based on the difference in cost between preparing  food at home versus eating out. Additionally, households may spend  money on goods they are not consuming themselves, such as charitable  contributions or gifts. Alternatively, some low-income families may receive  benefits from public assistance programs that allow for higher levels of  consumption than out-of-pocket spending indicates. For example,  households may be eligible for programs that offset some of the costs of  certain expenses, such as reduced-price school lunch or subsidized  housing. Nevertheless, with a substantial portion of spending going  toward basic expenses, households with limited resources may not have  much flexibility to adjust spending levels. Consequently, a household’s  socioeconomic status could affect the level of resources required to plan  for future spending needs.

section_title: Spending, Household Characteristics, and Earnings Are Key Factors Used by Researchers and Financial Professionals to Develop Target Replacement Rates
subsections: section_title: Changes in Spending Are Important to Account for When Deciding How Much Income Should Be Replaced in Retirement
paragraphs: We found that accounting for how a household’s spending may change in  retirement is an important step in determining a target replacement rate— that is, a recommendation for how much pre-retirement income an  individual or household needs to replace in retirement. According to the  articles and reports we reviewed, assumptions need to be made about  the direction and size of a number of expenses, including housing, health  care, entertainment, and consumer goods. For example, a retired  household may spend less on housing if it pays off a mortgage or  downsizes at retirement (see table 3). Alternatively, spending on housing  may increase if a retiree moves into specialized senior housing. The  amount a retired household will spend on health care may fluctuate  because health care costs can be variable and premiums and out-of- pocket medical costs may rise. Further, spending on entertainment and  consumer goods may also fluctuate, according to the articles and reports  we analyzed. Entertainment spending could increase because retirees  have more leisure time, or alternatively, it is possible that it decreases  due to the prevalence of entertainment-related senior discounts. In  addition, spending on consumer goods and services, such as ready-to- eat foods or car repairs, may be less in retirement than before because  retired households have more free time to engage in in-home production,  which includes activities like cooking and household chores and repairs.  Moreover, consumer durables purchased prior to retirement, such as  furniture or household appliances, may continue working well into  retirement and may not need to be replaced.

Further, researchers make assumptions about why overall spending  might change in retirement and the role of socioeconomic status, or  income level, before retirement. For example, some researchers have  proposed that consumption, for which spending is a proxy, declines in  retirement and households are generally content with consuming less as  retirement progresses. Alternatively, households may aim to smooth their  consumption over their lifetime and, thus, the goal in retirement is to  maintain the same level of consumption or spending as prior to  retirement. Under this theory, households that spend less in retirement  may do so because of income constraints. Some researchers have  explored the role that socioeconomic status plays in determining target  replacement rates. They have found that targets may vary by income  level. Lower-income households may need a higher replacement rate  because they spend a relatively high proportion of their income on  nondiscretionary items, such as food. Theoretical perspectives about  spending could influence the assumptions used to calculate a target  replacement rate.

Assumptions about households’ tax liabilities also affect estimates of how  much income is needed to cover expenses in retirement, and target  replacement rates. Not only do tax liabilities vary across households, they  can also vary before and after retirement. For example, retirees may be in  a lower tax bracket after retirement. In addition, Social Security benefits  are partially or fully tax free, and according to some researchers, there  are more income tax deductions for those aged 65 and older.

section_title: Household Size Also Affects Income Needs in Retirement
paragraphs: According to the articles and reports we reviewed, household  characteristics, particularly household size, play an important role in  determining a household’s expenses, its income needs in retirement, and  a target replacement rate (see table 4). For example, the presence of  children could also affect what a target replacement rate should be.  Researchers do not agree on how having had children affects a retired  household’s income needs. According to some researchers, retirees will  focus on maintaining spending on themselves and will not need to replace  income that went toward their children’s consumption. Further, some  researchers have hypothesized that after children move out, the  household will save more; and because the household saves more,  leaving less money to spend during its remaining working years, the  percentage of income that needs to be replaced in retirement is reduced.  On the other hand, other researchers have theorized that once children  move out, households may not actually consume less. Instead, the  parents may choose to use the money they had spent on their children on  themselves. Thus, the percentage of income needed to be replaced in  retirement may not be lower for retirees who had children versus those  who did not.

However, household characteristics may not be static, making choosing a  target replacement rate even more complex. For example, spouses may  not retire at the same time. Further complicating matters is the fact that  retirees may marry, divorce, or become widowed, changing the size of  their household and the replacement rate needed to cover the  household’s income needs.

section_title: Target Replacement Rates Can Vary by Pre- Retirement Earnings Level or if Different Definitions of Earnings Are Used
paragraphs: Low earners had the highest target replacement rates and high earners  the lowest target rate, according to studies we reviewed. Some of the  studies in our review developed different target rates for workers based  on earnings level before retirement. While these studies did not use the  same earnings-level groups, their conclusions were consistent.  Specifically, Aon Hewitt projected that workers earning under $30,000  would need a 98 percent replacement rate and that workers earning  $90,000 would need to replace 79 percent of their income. Lower  earners may need a higher replacement rate for three reasons. First, as  discussed earlier, they may spend a relatively high amount of their  income on non-discretionary items. Second, research has shown low- income households save less than higher-income households. Thus, the  reduction in saving in retirement will be less substantial for low-income  households and they may need a higher replacement rate. Third,  because low-income households pay little in taxes, they receive little in  the way of tax saving in retirement.

In addition, how pre-retirement earnings are defined and calculated can  have important implications for target replacement rates. More  specifically, developers of target replacement rates must decide upon a  period of earnings to use (see table 5). Two options cited by the articles  and reports in our review are final average earnings and average  earnings over the course of a career. A final average earnings measure  uses the average of annual earnings for a period of time leading up to  retirement. Career average earnings measures, on the other hand, use  the average of annual earnings over the course of someone’s career,  adjusted for inflation or wage growth. Furthermore, because different  definitions of earnings can affect the final target replacement rate, it is  important to understand how earnings were calculated and indexed. For  example, adding up separate replacement rates provided by defined  benefit plans and Social Security benefits to come up with a total  replacement rate may not be accurate if the two rates did not use the  same type of pre-retirement earnings or index these earnings the same  way.

Other decisions may need to be made about how to account for work  histories or changes in earnings or phased retirement. For example,  women often have shorter careers than men. They tend to take a greater  number of breaks from the labor force to care for children and elderly  relatives. As a result, a replacement rate that uses career average  earnings could be distorted by these breaks. In addition, changes to  earnings late in a career can have a substantial effect on target  replacement rates if final average earnings are used to calculate pre- retirement income. Phased retirement could also change a target  replacement rate, depending on how it is incorporated into the calculation.  For example, if workers phase into retirement by reducing their hours and  earnings over a number of years, then using the average of the final 5  years of earnings could result in a much lower measure of pre-retirement  income than using career average earnings. Similarly, how retirement  income is defined can have implications for target replacement rate  recommendations. For more information on how the definition of  retirement income and other factors can affect target replacement rates,  see appendix IV.

section_title: Some Financial Professionals Recommend Target Replacement Rates While Others Question Their Usefulness
paragraphs: Six of 14 (or 43 percent) of the service providers, consultants, and  financial planners who responded to our questionnaire recommend a  target replacement rate to plan participants or clients. Four of the six  developed customized replacement rate targets for plan participants and  used information such as asset levels, expected spending, and household  composition to calculate target rates. One service provider told us it uses  answers to five multiple-choice questions that ask about lifestyle  preferences and spending patterns, along with information about  retirement accounts, to calculate customized target replacement rates for  most plan participants. Two other respondents reported using simplified  “rules of thumb.”

The remaining eight service providers, consultants, and financial planners  do not recommend a retirement replacement rate and questioned their  usefulness for plan participants or clients. For example, according to one  consultant, using a set rate or a rule of thumb is not appropriate for  everyone. In addition, two financial planners told us that income needs in  retirement are typically expense- or goals-based or income-based.  Further, they explained each household’s income needs are unique and  may change over time.

Researchers have also cited concerns about the usefulness of  replacement rates in their current form. In particular, a 2011 report by  MacDonald and Moore found that any one target rate fits relatively very  few individuals. Further, the authors explained that there is no  consensus on the best approach to estimate replacement rates and that  its conceptual grounding in past research has often been weak.

The number of different replacement rates cited in the literature also calls  into question the extent to which replacement rates are useful. We  identified about 500 references to target replacement rate  recommendations in 52 articles and reports (see fig. 4). These  recommendations were either cited as rules of thumb or analysis results.  The recommendations ranged from 43 to 476 percent of pre-retirement  income, with the majority of the references being between 70 and 85  percent of pre-retirement income; the median recommended target  replacement rate was 77 percent.

Despite their inherent limitations, particular groups of workers may find  replacement rates to be a useful planning tool, making it important that  these groups receive clear information on replacement rate  recommendations, according to the articles and studies in our review. For  example, target replacement rates may be more useful for low- and  middle-income households in part because they are more likely to face  budget constraints in retirement and will likely need a higher replacement  rate compared to high-income households. Also, many individuals lack  basic financial knowledge, and lower- and middle-income individuals  scored lower on a recent national financial capability assessment.  Replacement rates may also be useful for younger individuals because  they can use a replacement rate as a metric to estimate if their projected  retirement savings are reasonable.

Further, the 2011 MacDonald and Moore report concluded that the  replacement rate literature is becoming more sophisticated and capable  of providing better guidance. It found that incorporating some individual  characteristics—such as income and family size—could improve the  usefulness of replacement rate calculations. Customizable replacement  rates could be one alternative to universal target replacement rate  recommendations. We found that there are numerous calculators and  tools available online to help individuals determine how much they need  to save, but research has found wide variability in how such programs  work and in the outcomes they produce. Given that variability, some  researchers have expressed concern that individuals may be unable to  identify tools that are relevant for their individual circumstances. With  regard to target replacement rates, we found some online tools that used  target replacement rates in calculations did not permit users to adjust the  value of the rate. Though we also found several that allowed users to  adjust the rate used and provided additional—but still concise— information to help users select an appropriate rate. For example,  AARP’s retirement saving calculator provides replacement rate defaults  corresponding to three different lifestyle options as well as the ability to  adjust the replacement rate to any whole number.

section_title: Limited Explanation of Replacement Rates in Department of Labor Retirement Planning Materials May Leave Workers Uncertain about How to Use Them
paragraphs: DOL’s Employee Benefits Security Administration (EBSA) provides  guidance on retirement income savings for workers via a number of  publications available in print and online. For example, EBSA provides a  brief and simple explanation of retirement replacement rates in retirement  planning materials and guidance for workers. Among EBSA’s retirement  planning publications is one that is intended to help younger workers  understand how much they need to save for retirement. The publication  includes worksheets to help workers calculate their savings needs and it  is available in print and as an interactive online tool. This document notes  that replacement rates might vary depending on an individual’s  circumstances (see fig.5).

The publication notes that no rule of thumb is appropriate for all  individuals and also includes information that some expenses may  change in retirement and descriptions of some lifestyle choices that may  affect how much income workers need to replace (see fig. 5). Despite  DOL’s appropriate acknowledgement of such considerations, its  worksheet for calculating how much to save each year assumes a fixed  replacement rate of 80 percent. The worksheet assumes that Social  Security benefits will provide about 40 percent of pre-retirement income  and the remaining 40 percent would need to come from savings. While  the previous page explains that the replacement rate provided is an  estimate and the user may need more or less depending on their  circumstances, “x .40” is pre-printed in the worksheet for users to  calculate the amount of savings needed when they retire (see fig. 6).

Similarly, in the interactive online version of Savings Fitness, the fixed  target replacement rate is coded into the calculation and cannot be  changed. DOL officials told us that they worked to balance accuracy with  simplicity by presenting information in a concise manner that will not  overwhelm users. Specifically, they said that they did not make the rate  adjustable in order to limit user flexibility and prevent too wide a range in  assumptions. They also indicated that they limited the information on  factors that could affect replacement rates to keep the document from  being too complex and cluttered. ERISA calls for DOL to provide on its  website “a means for individuals to calculate their estimated retirement  savings needs based on their retirement income goal as a percentage of  their preretirement income”. While the planning tool allows workers to  estimate their savings needs based on a percentage of their  preretirement income, they are constrained in setting an individual  retirement income goal as the replacement rate is preset by DOL. Without  the ability to adjust the replacement rate used in the tools, workers may  over- or under-estimate how much they need to save for retirement.

In addition, the Savings Fitness explanations provided concerning the  replacement rate in the calculation do not include specific information on  demographic groups that studies suggest generally need higher or lower  replacement rates, such as low-income and single workers. For example,  one study found that the median optimal target replacement rate for  singles was 55 percent compared to 75 percent for married couples.  Also, we found no discussion in the EBSA materials about how much the  replacement rate provided might need to be adjusted for the examples of  circumstances that might affect an individual’s desired replacement rate.  For instance, though it suggests that someone who wants to travel  extensively will need more money in retirement, there is no information on  how to adjust the replacement rate to account for such a situation. Such  information and guidance could help workers assess whether they need  to customize the rate used in their own calculations.

Academic and industry-based researchers consistently state that there is  no one-size-fits-all target, and some note that averages can be  misleading and dangerous for personal planning purposes. They also  highlight particular demographic groups that often need higher or lower  income replacement (married vs. single; with/without children; by income  level). Financial literacy research highlights the necessity of using  relatable examples and realistic scenarios, targeting by income, and  tailoring communications as effective means of educating and motivating.  For instance, one review of retirement planning software suggests that  such tools should provide the user assistance in setting a target  replacement rate and should recognize the different needs of those with  and without children. Similarly, an ERISA Advisory Council report cited  research that found that communications specifically targeted to  participants based upon their interests, background, and/or economic  status were more successful than providing general communications.

section_title: Conclusions
paragraphs: Income replacement rates may be a helpful gauge for younger workers  who have time to contribute more to retirement plans or adjust their  saving. They can also be a useful metric for low- and middle-income  households that may find they need to plan for replacing a substantial  portion of their pre-retirement income in retirement. These households, in  particular, may find they need to spend a sizable portion of their  retirement income on basic needs, such as housing and health care.  Social Security’s progressive benefit structure will help these households,  but they will need other sources of income in retirement through defined  contribution plans, pension benefits, or other means to make up the  difference. At the same time, however, reports and articles we reviewed  demonstrate that developing a customized replacement rate requires  careful consideration to appropriately balance all of the underlying  assumptions, including those related to determining pre-retirement and  retirement income. The wide range of recommended target replacement  rates cited in research indicates that there is no rule-of-thumb that will  work for everyone.

Given these factors, workers may have difficulty understanding what  target replacement rate to use based on their circumstances. Further,  workers may have trouble operationalizing this information into a realistic  savings strategy. This difficulty could be compounded by challenges in  understanding how to convert defined contribution account balances into  a potential income stream. If workers are unable to translate retirement  account balances into income replacement goals, the benefit of  replacement rates as a metric or guide is limited.

Despite their complexity, replacement rates are used in some of the  retirement planning tools produced by the financial industry to give  workers a general sense of their progress toward achieving a secure  retirement. DOL’s tools, however, lack targeted information and guidance  that could help different groups of workers make reasonable adjustments  to the replacement rates used in estimating their savings needs. This type  of clarifying information is particularly important given the challenges  workers may face in understanding the multitude of factors that could  affect a target replacement rate. Additionally, DOL’s tools do not provide  flexibility to allow a user to customize or compare rates. Stating a rule-of- thumb target replacement rate, for example, and then using it in planning  tools without an option to adjust it, may inadvertently and implicitly  endorse a “right” rate. Without additional information and guidance on  how to estimate how much money they will need in retirement and the  flexibility to adjust the rate used in the calculations, workers could over- or  under-estimate how much they need to save. As a result, they may give  up on saving if estimates seem unattainable or they could unknowingly  save too little. In both cases, workers could reach retirement without  adequate savings.

section_title: Recommendations for Executive Action
paragraphs: To help workers make appropriate adjustments to the replacement rates  used in calculating their specific retirement income needs, the Secretary  of Labor should take the following two actions:  Include in its retirement planning tools information about examples of  individual circumstances that research has shown to result in higher  or lower income replacement needs (e.g., household characteristics  and income level) and guidance on the direction and magnitude of the  changes attributable to such circumstances as well as those due to  particular lifestyle choices.

Modify its retirement planning tools to allow for some user flexibility in  adjusting the replacement rate used in calculating retirement income  needs.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this product to the Department of Labor (DOL),  Department of the Treasury, Social Security Administration, and  Consumer Financial Protection Bureau. DOL provided written comments  which are reprinted in appendix VI. DOL also provided technical  comments that were incorporated as appropriate. The Social Security  Administration (see letter in app. VII), the Department of the Treasury,  and the Consumer Financial Protection Bureau did not have any  comments on our report.

In its written comments, DOL generally agreed with our findings and  recommendations. In its response, DOL cited steps taken by the  Employee Benefits Security Administration (EBSA) to ensure that  retirement planning materials balance key information with usability of the  tools, including working with key stakeholders and experts to develop and  test materials. DOL also noted that EBSA has worked to identify the most  common circumstances relevant to replacement rates to help make  workers aware of the possible impacts, rather than to create an  individualized tool. To address our recommendations for providing more  information on using replacement rates and modifying tools to allow for  more flexibility, EBSA plans to make two changes by June 2017. First,  EBSA plans to add an example about replacement rates specifically for  married couples. Second, EBSA plans to add options to its online  retirement savings rate tool to allow users to adjust their income  replacement rate and their Social Security replacement rate within an  accepted range. We agree that additional information on using  replacement rates and increased user flexibility will further help workers  make appropriate adjustments in calculating their specific retirement  income needs.

We are sending copies of this report to the appropriate congressional  committees, the Secretary of Labor, the Secretary of the Treasury, the  Acting Commissioner of the Social Security Administration, and the  Director of the Consumer Financial Protection Bureau. In addition, the  report is available at no charge on GAO’s website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202)-512-7215 or jeszeckc@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made major contributions to  this report are listed in appendix VIII.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: To analyze consumption in retirement and how target replacement rates  are defined and used to assess retirement readiness, we examined (1)  whether and how spending patterns have varied by age; (2) the key  factors used to develop target replacement rates for how much income  workers need to replace in retirement; and (3) the usefulness of  information on replacement rates provided to workers by the Department  of Labor. This appendix provides a detailed account of the data sources  used to answer these questions and the analyses we conducted. The  appendix is organized into three sections. Each section presents the  methods we used for the corresponding objective. Specifically, section I  describes the information sources and methods we used to analyze  whether and how spending patterns have varied by age. Section II  describes the information sources and methods we used to identify key  factors used to develop target income replacement rates for retirement.  Section III describes the information sources and methods we used to  examine the information on replacement rates provided by federal  agencies.
subsections: section_title: Section I: Analyzing Spending Patterns Using Consumer Expenditure Survey Data
subsections: section_title: Consumer Expenditure Survey
paragraphs: To understand how spending patterns varied by age, we analyzed data  from the 2013 Consumer Expenditure Survey (CE). This was the most  recently available data at the time of our review. CE is a program that  consists of two ongoing surveys, the Quarterly Interview Survey and the  Diary Survey, that provide information on the buying habits of American  consumers, including data on their expenditures, income, and consumer  unit characteristics. The survey data are collected for the Bureau of Labor  Statistics (BLS) by the U.S. Census Bureau. Based on our interest in  conducting a broad analysis of spending patterns, we chose to use the  Interview Survey rather than the Diary Survey, since the Diary Survey is  designed to capture information on small, frequently purchased items. In  contrast, the Interview Survey is designed to collect data on major items  of expense, which respondents can be expected to recall for 3 months or  longer. In practice, the Interview Survey collects detailed data on an  estimated 60 to 70 percent of total household expenditures. In addition,  global estimates are obtained for food and other selected items, which  account for an additional 20 to 25 percent of total expenditures. The  Interview Survey does not collect expenses on housekeeping supplies,  personal care products, and nonprescription drugs, which contribute  about 5 to 15 percent of total expenditures. Thus, up to 95 percent of total  expenditures are covered by the Interview Survey.

CE uses a probability sample of households designed to be  representative of the total U.S. non-institutionalized civilian population.  Prior to 2015, the sampling frame was generated from the 2000 Census  of Population. The Interview Survey is a rotating panel survey. According  to a BLS official, consumer units in each panel complete four interviews  conducted every 3 months and are then dropped. Each month new  consumer units enter the survey as other consumer units complete their  participation. The quarterly target sample size for the Interview Survey is  7,060 participating sample units. Data are weighted to adjust sample  estimates to national population estimates. The results for our weighted  data represent approximately 125.7 million households. We also  accounted for the number of months a household is interviewed. Sample  surveys are subject to two types of errors, sampling and non-sampling.  Sampling errors occur because observations are not taken from the entire  population. To estimate sampling error, we calculated 95 percent  confidence intervals. Total expenditure data estimates reported have 95  percent confidence intervals that are within +/- 17 percent of the estimate  itself, and additional confidence interval information on individual  spending categories are provided in appendix III. We followed BLS  guidance and estimated standard errors using a replicate weight  methodology, which involved taking the variance across 44 separate  values of differently weighted estimates. Non-sampling error can be  attributable to many sources, such as differences in interpreting  questions, inability or unwillingness of the respondent to provide correct  information, and mistakes in recording or coding data. These non- sampling errors can influence the accuracy of information presented in  the report, although the magnitude of their effect is unknown.

We found the 2013 CE Interview Survey data to be reliable for the  purposes of our report. To assess reliability, we reviewed survey  documentation, compared results to published tables, and interviewed  agency officials to ensure the variables we analyzed were reliable for our  purposes. Estimates produced in this report may differ from published  BLS tables. For our analysis, we only analyzed Interview Survey data,  whereas BLS integrates some Diary Survey data into published tables.  For the purposes of our analysis, we used different age groups than those  in BLS published tables, which can also account for differences.  Additionally, averages for some income and expenditure items in CE  publications differ from those derived from Interview Survey public-use  microdata because some variables are top coded or suppressed for  public-use files.

section_title: Cross-Sectional Spending Analysis
paragraphs: We compared estimates for average household spending levels and  shares of expenditure categories across 5-year age groups. Expenditure  data are tracked for each consumer unit, which can comprise (1) all  members of a household related by blood, marriage, or other legal  arrangement, (2) a person living alone or sharing a household but who is  financially independent, or (3) two or more persons living together who  make joint expenditures. For the purposes of this report, we refer to  consumer units as households. Households were included in age groups  depending on the age of the reference person of the consumer unit. The  reference person is the first member mentioned by the respondent when  asked to identify the name of the person or one of persons who owns or  rents the home.

We defined spending as direct out-of-pocket expenditures. In our  analysis, each household had an observation for each expenditure type.  Indirect expenditures, which may be significant, may be reflected  elsewhere. For example, consumer units with members whose employers  pay for all or part of their health or life insurance would have lower direct  expenses for these items than those who pay the entire amount  themselves. All monthly expenses were summed to obtain quarterly  estimates for each household. In cases where no expenditure was  reported, the expenditure was coded as a zero. We then multiplied  expenditures by four to annualize quarterly expenditure estimates.  Households in the four quarters of data were then averaged to obtain  annual expenditures. To analyze the shares of different categories of  spending, we grouped detailed level expenditures into broader  categories, such as health and housing, based on BLS’s aggregation  method. One exception was that we combined some broad expenditure  categories into an “other” category for reporting purposes.

The personal insurance and pensions category includes private pensions.  According to BLS officials, private pensions capture contributions to  defined benefit, defined contribution, and individual retirement accounts.  CE expenditure variables do not include payments on loans, such as  principal payments on home mortgages because BLS considers these  data as shifts in assets and liabilities, and would be captured in outlays.

Outlays include out-of-pocket expenditures plus spending that “stays  within the consumer unit” such as paying down principal on a loan. The  figures in this report that are based on our analysis of the Consumer  Expenditure Survey reflect data that are defined as expenditures in BLS  documentation. However, since mortgages can play an important role in  homeownership, we conducted an additional analysis where we added  lump sum and mortgage principal payments to housing expenditures to  understand the difference between housing outlays and expenditures. We  found that including mortgage outlays does not substantially alter the  spending patterns observed. For information on home mortgage outlays,  see appendix II. Property taxes are included in housing expenditures.  Lastly, income tax estimates are separate from expenditure variables. In  2013, CE started using the National Bureau of Economic Research  TAXSIM program to estimate tax liabilities because it can be difficult for  respondents to accurately recall and estimate income taxes.

We also analyzed expenditure levels by age-specific income quartiles.  The income quartile thresholds for each age group are presented in   table 6.

We also analyzed spending patterns by age for expenditures related to  long-term care services since long-term care costs may be a particularly  salient issue for older households. Specifically, we looked at spending on  long-term care insurance; care in convalescent or nursing home; adult  day care; and care for elderly, those who are incapacitated, individuals  with disabilities, etc. However, there are challenges with measuring  household spending for long-term care because there is uncertainty  surrounding the extent to which households will need long-term care  services and how they will finance these costs. Since many people may  not have spending in this area, average spending levels are not  necessarily indicative of the potential costs people may face. Thus, to  better understand how long-term care costs would factor into retirement  considerations, we compared the results of four academic studies that  studied the potential effect of these costs on retirement resources. We  selected these articles based on our general literature search results and  citations in relevant studies. See appendix V for more information on  long-term care costs.

section_title: Regression Analysis
paragraphs: Using the same CE Interview Survey data, we analyzed whether there  were differences in spending patterns by category using a regression  analysis. Specifically, we estimated the following aspects of spending  patterns: (1) the age at which the expenditure category is at its maximum,  and (2) whether there is a significant relationship between age and  expenditures. Our regression model tested the effect of age on  expenditures while controlling for education, race, and ethnicity. We used  the natural log of expenditures as the dependent variable in order to  obtain results for the percentage effect of age on expenditures rather than  the absolute effect. Based on the results of our cross-sectional analysis,  which showed a parabolic pattern in expenditure levels by age, we used a  quadratic form of age. We included a limited set of control variables that  were not affected by age so as to capture the effect of age as well as  other characteristics that may change with age. Because we used cross- sectional data, the results may not accurately describe how an actual  cohort might behave over time.

Our regression model is represented by the following equation:  Ln(expenditure) = α + β1*age + β2*age + control variables. We then  solved for the age at which expenditure is maximized by taking the first  derivative with respect to age, and solving for the age at which the first  derivative is equal to zero, - β1/(2∗β2).

section_title: Section II: Identifying Key Factors Used by Researchers and Financial Professionals to Develop Target Replacement Rates
paragraphs: To identify key factors used to develop target replacement rates, we (1)  analyzed articles and reports published in academic journals or by  research centers or international organizations and (2) gathered  information from financial firms through questionnaires and interviews. To  identify the range of target replacement rates recommended to U.S.  workers, we catalogued references to such recommendations in the  studies we selected for review. Our analysis focused on total replacement  rates, that is, the ratio of all income in retirement—including from Social  Security, pension benefits, and retirement savings—to pre-retirement  earnings. We sought to identify a number of considerations that  researchers, policy makers, and financial professionals incorporate into  their assumptions when developing, calculating target, or evaluating  replacement rates. However, because analyzing the merits and  disadvantages of each consideration was outside the scope of our work,  GAO is not endorsing any of the considerations presented in this report.

To select articles and reports for our analysis, we used ProQuest,  WorldCat, and PolicyFile to search various library databases such as  EconLit and ABI/INFORM Global. We also searched the OECD library.  We also reviewed websites of research centers and industry  organizations that work on retirement security issues, such as the Center  for Retirement Research at Boston College, the University of Michigan  Retirement Research Center, the Society of Actuaries, the Employee  Benefit Research Institute, and the World Bank. We also reviewed written  statements of witnesses at congressional hearings held by the House  Committee on Ways and Means; House Education and the Workforce  Committee; Senate Committee on Finance; Senate Committee on Health,  Education, Labor and Pensions; and Senate Special Committee on  Aging. Our ProQuest and PolicyFile searches generated 555 results. Our  OECD library searches generated 35 results and our web searches  generated another 40 results. We reviewed relevant abstracts, when  available, to determine which articles (1) contained information on target  replacement rates or assumptions needed to calculate a replacement rate  and (2) were published in or after 2005, and reviewed those articles. We  selected 59 articles and reports for analysis (see bibliography at the end  of this report for the list of reports and articles selected). We performed  these searches and identified articles from January 2015 through January  2016. We included reports published by international organizations  because these reports include detailed information on assumptions and  methods used to calculate replacement rates. These reports generally  use replacement rates primarily for cross-country comparisons. For  example, the OECD’s Pensions Outlook calculates replacement rates for  cross-country comparisons. This OECD report considers several  definitions of pre-retirement earnings to compute replacement rates and  shows the proportion of workers in a given country who may fail to reach  the OECD average replacement rate and the country-specific target  replacement rate, if any.

To gather information from financial industry firms, we used a  combination of questionnaires and interviews. To determine which firms  to contact, we relied on suggestions from several researchers and  actuaries who have studied replacement rates. We collected information  from 14 firms—7 service providers, 3 retirement services consulting firms,  and 4 financial planners. While these firms provided valuable insight into  target replacement rate recommendations, our findings are  nongeneralizable. We asked the firms to respond to a questionnaire we  developed, either by completing the questionnaire and sending it back to  us or by going through the questionnaire during an interview. The  questionnaire asked about how, if at all, the firm uses replacement rates  in its work. If the firm uses target replacement rates, we asked a series of  questions about the origin of the target rate used by the firm, when and  how it was developed, and the various economic and demographic  factors considered, if any, when the firm developed the replacement rate.  For example, the questionnaire asks about individual or household  demographic factors, economic factors specific to an individual or a  household, and macroeconomic factors, like inflation and wage growth. If  the firm does not use a target replacement rate, we asked about  alternative measures it uses in lieu of replacement rates.

To identify target replacement rates recommended to U.S. workers, we  reviewed our selected studies for (1) references to rules of thumb for  income replacement rates in retirement, (2) references to target rates  recommended by other researchers or organizations, and (3) target  replacement rates recommended or developed by the report’s authors.  For this particular part of analysis, we excluded articles and reports  written by international organizations because of our focus on  recommendations for U.S. workers.

section_title: Section III: Assessing the Usefulness of Information on Replacement Rates Provided by Federal Agencies to Workers
paragraphs: To identify the information on replacement rates provided to workers by  federal agencies, we interviewed officials and reviewed relevant  retirement planning materials produced by the Department of Labor  (DOL), the Social Security Administration (SSA), and the Consumer  Financial Protection Bureau (CFPB). We also interviewed officials at all  three agencies. In addition to reviewing documents provided to us by  agency officials, we conducted web searches to identify any additional  relevant materials. We also reviewed the websites of the Pension Benefit  Guaranty Corporation, the Securities and Exchange Commission, and the  Administration on Aging for retirement planning documents that might  contain references to replacement rates. We included these agencies  because of references we found in DOL and SSA retirement planning  materials. Although we found references to replacement rates in SSA and  CFPB documents, we focused our review on DOL materials as DOL is  required by law to provide a means of calculating retirement savings  needs using a replacement rate. and 2013  Advanced Notice of Proposed Rulemaking on Pension Benefit  Statements for remarks specific to the provision of information about  replacement rates or pension benefits in individual benefit statements.

See 29 U.S.C. § 1146(d).

section_title: Appendix II: Home Mortgage Outlays
paragraphs: Housing is unique from most spending categories in that certain financial  aspects of homeownership are considered an asset for households, and  financing plays an important role in purchasing a home. For several age  groups, we found that a large portion of households owned a home with a  mortgage (see fig. 7).

While certain out-of-pocket expenses associated with homeownership,  such as mortgage interest payments and property taxes, are captured by  the Consumer Expenditure Survey (CE) expenditure variables, mortgage  principal payments are not included in expenditures. Rather, payments  of mortgage principal are considered a shift in a household’s assets and  liabilities. To get a sense of the household’s total outlays for housing, we  conducted an additional analysis of 2013 CE data on owned and vacation  home mortgage principal and lump sum payments, referred to here as  mortgage outlays. When mortgage outlays were added to housing  expenditures, the share of spending on housing increased somewhat  (see table 7).

Mortgage outlays were larger for some age groups than others. For  example, estimated average mortgage outlays were around $3,000 for  mid-career households (aged 45-49). However, for some age groups,  such as households aged 75 and older, average mortgage outlays were  quite small. While mortgage principal payments are an important  expense for some households, their inclusion does not substantially alter  the spending patterns observed. More specifically, housing was a major  household expense across all age groups regardless of whether or not  mortgage outlays are included.

section_title: Appendix III: Confidence Intervals for Select Spending Estimates
paragraphs: The tables below provide the underlying spending estimates and  confidence intervals for table 1, table 2, and figure 2.

section_title: Appendix IV: Other Factors That Could Inform Target Replacement Rates
paragraphs: We identified four factors from the articles and reports we reviewed in  addition to spending, household characteristics, and pre-retirement  earnings that raised important considerations for developing the  underlying assumptions behind a target replacement rate. As shown in  table 11, these four factors are (1) the income to be replaced, (2) sources  of income in retirement, (3) saving patterns, and (4) risks.

section_title: Appendix V: Long-term Care Costs and Effect on Retirement Resources
paragraphs: Based on the studies we reviewed in table 12, long-term care (LTC) is an  important consideration for retirement, particularly since a majority of  users for these services are elderly. About 70 percent of those aged 65  and older are likely to need long-term services and supports at some  point in their lives. However, it is difficult to plan for LTC costs as part of  income replacement in retirement because of challenges in determining  spending needs, high service rates, and limited government coverage for  financing costs. Average LTC spending is not necessarily indicative of the  potential costs individuals may face because the distribution of costs is  skewed. While many may not require LTC services, those who do may  have significant spending. For example, in our analysis of 2013  Consumer Expenditure Survey data, we found that only 3 percent of  households we analyzed had out-of-pocket spending on LTC-related  expenses. Estimated expenditures were sizeable in some age groups for  those who had spending on these services. For example, households  aged 80 and older that did have long-term care expenses spent an  average of about $6,900 in 2013. Further, LTC service rates can be  expensive. According to 2015 Genworth Cost of Care Survey data, the  national median annual service rate for nursing homes was $80,000 and  was $46,000 for full-time home health care. Although government  programs can help individuals finance LTC costs, coverage from these  programs is limited. For example, Medicaid does provide coverage for  some long-term care services, but coverage is limited to individuals who  are within certain eligibility categories and meet functional and financial  criteria. Individuals who pay for an extended stay in a nursing home can  quickly deplete their resources for retirement and subsequently quality for  Medicaid.

To understand how the potential for LTC costs affects retirement  adequacy, we reviewed four academic studies (see table 12). The results  show that incurring long-term care costs can have a negative impact on  retirement readiness, particularly for low- and middle-income households.

section_title: Appendix VI: Comments from the Department of Labor

section_title: Appendix VII: Comments from the Social Security Administration

section_title: Appendix VIII: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Kimberley Granger (Assistant  Director), Jennifer Gregory (Analyst in Charge), Mindy Bowman, and  Amrita Sen made key contributions to this report. Also contributing to this  report were Benjamin Bolitzer, David Chrisinger, John Dicken, Gustavo  Fernandez, Alexander Galuten, Mark Glickman, Isabella Johnson, Kathy  Leslie, Mimi Nguyen, Oliver Richard, Frank Todisco, Walter Vance, and  Seyda Wentworth.

section_title: Bibliography
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section_title: Related GAO Products
paragraphs: Federal Low-Income Programs: Multiple Programs Target Diverse  Populations and Needs. GAO-15-516. Washington, D.C.: July 30, 2015.

Retirement Security: Most Households Approaching Retirement Have  Low Savings. GAO-15-419. Washington, D.C.: May 12, 2015.  401(k) Plans: Other Countries’ Experiences Offer Lessons in Policies and  Oversight of Spend-down Options. GAO-14-9. Washington, D.C.:  November 20, 2013.

Medicare Supplemental Coverage: Medigap and Other Factors Are  Associated with Higher Estimated Health Care Expenditures.   GAO-13-811. Washington, D.C.: September 19, 2013.  401(k) Plans: Labor and IRS Could Improve the Rollover Process for  Participants. GAO-13-30. Washington, D.C.: March 7, 2013.

Retirement Security: Women Still Face Challenges. GAO-12-699.  Washington, D.C.: July 19, 2012.

Financial Literacy: Enhancing the Effectiveness of the Federal  Government’s Role. GAO-12-636T. Washington, D.C.: April 26, 2012.

Defined Contribution Plans: Approaches In Other Countries Offer  Beneficial Strategies In Several Areas. GAO-12-328. Washington, D.C.:  March 22, 2012.

Retirement Income: Ensuring Income throughout Retirement Requires  Difficult Choices. GAO-11-400. Washington, D.C.: June 7, 2011.  401(k) Plans: Improved Regulation Could Better Protect Participants from  Conflicts of Interest. GAO-11-119. Washington, D.C.: January 28, 2011.

Retirement Savings: Better Information and Sponsor Guidance Could  Improve Oversight and Reduce Fees for Participants. GAO-09-641.  Washington, D.C.: September 4, 2009.


Question-summary annotations: questions: question: How did household spending patterns vary by age?
answer: Household spending patterns varied by age, with mid-career households (those aged 45-49) spending more than older households.
child_questions: question: How did household spending patterns vary by spending category?
answer: While the share of spending was consistent for some categories, other categories had larger variations across age groups. For example, housing expenses comprised the largest share of spending regardless of age, while older households spent more out of pocket on health care than mid-career households.

question: How did spending compare between low-income households?
answer: Spending was less variable across age for low-income households compared to other households.

question: What do spending patterns have implications for?
answer: These variations in spending patterns have implications for the resources households need to maintain their standard of living in retirement.

questions: question: How do researchers and financial industry professionals develop target replacement rates?
answer: Researchers and financial industry professionals develop target replacement rates—the percentage of income to aim for in retirement— based on certain key factors, including spending, household characteristics, and pre-retirement earnings.
child_questions: question: What did GAO's analysis find about replacement rates?
answer: GAO's analysis of the literature found that calculating an appropriate replacement rate can be complex.

question: What can a worker's pre-retirement earnings be defined as?
answer: In addition, a worker's pre-retirement earnings could be defined as earnings at the end of the worker's career or as average earnings over the course of the career.

question: What do target replacement rates range between?
answer: Despite these complicated considerations, target replacement rates cited in the articles and reports GAO reviewed typically range between 70 and 85 percent.

question: What do some financial industry professionals do regarding target replacement rates?
answer: Some financial industry professionals told GAO that they develop customized targets that take into account workers' assets and expected spending, while others questioned the usefulness of replacement rates.

questions: question: How are are the information and tools on replacement rates that the DOL provides?
answer: The information and tools on replacement rates that the Department of Labor (DOL) provides may be too limited to help workers understand how to use such rates for retirement planning.

question: What does the EBSA website provide?
answer: DOL's Employee Benefits Security Administration's (EBSA) website provides information and tools to help American workers better plan for retirement, including a tool to help workers calculate their retirement income needs as a percentage of preretirement income.

question: What do EBSA's materials not have?
answer: While EBSA's materials note that a target replacement rate can vary based on individual circumstances, they do not include specific examples of demographic groups that research indicates can result in higher or lower income replacement needs, or how much a replacement rate might need to be adjusted for those groups or for other individual circumstances.
child_questions: question: Why is this problematic?
answer: Without additional information, workers may not understand how to adjust target replacement rates when planning for retirement.

question: Why is it problematic that users can't adjust replacement rates on EBSA's online tools and worksheet?
answer: Without the ability to adjust the replacement rates used in planning tools, workers may over- or under-estimate how much they need to save for retirement.

questions: question: What is part of DOL's mission?
answer: Part of DOL's mission is to promote the retirement security of America's workers, a goal that has become increasingly challenging.

question: What is the purpose of the replacement rate?
answer: One tool for assessing the adequacy of retirement income is the replacement rate.
child_questions: question: Why should replacement rates vary widely?
answer: However, recommendations for the replacement rate that a household should target vary widely, in part because of the diverse underlying assumptions used to develop the rates.

question: What was GAO asked to review?
answer: GAO was asked to review what consumption in retirement looks like and how target replacement rates are developed.