2  Adequacy of retirement saving

2.1  Introduction

To address this question of whether or not individuals are saving adequately for retirement we build on the results of the Household Saving Survey.[3] The survey covered those over 18 years old living in private dwellings and usually resident in New Zealand.[4] The survey population covered about 98% of the resident adult population. For the core sample a total of 6,600 households were approached. One person from those qualifying in the household was chosen at random, and information was collected from and about that individual. In the case they had a partner, information was collected for the couple. In order to improve the accuracy of estimates for Maori, a booster sample was used. In total the response rate was 74% and the final number in the sample was 5,374 households. There were 2,392 individual interviews and 2,982 for couples. It is important to stress that the term household refers to the unit of selection. The results are for individuals (living as individuals or partnered) and not for households or families.

In the next section (2.2) we expand on the concept of adequacy. We then outline the model that we use (2.3) and present the results from the survey (2.4) and the modelling of retirement incomes (2.5). A comparison with the actual saving rates is given in Section 2.6 while Section 2.7 provides a comparison with some international estimates. Conclusions are presented in Section 3.

2.2  What is meant by adequacy?

Any attempt to assess how adequately New Zealanders are preparing for retirement through saving immediately must confront the question: how is “adequate” to be measured? By what criterion would we assess savings and the associated level of wealth accumulation for retirement to be adequate? What is seen as adequate may differ whether we have an individual or a collective perspective. From a public policy perspective we might focus on adequacy as it applies to the average of some group in the population; eg, would, on average, those aged between 55-60 with no dependants and having accumulated retirement wealth of $20,000 and having current income of $25,000 be considered to have saved “adequately”? Or should we recognise that within each group there will be wide variation and conclude that adequacy can only be addressed at the individual level? In that case our measure of adequacy might be say, that at least 90 percent of the group have retirement wealth deemed to be adequate; or perhaps 100%?

There is a range of measures that one might adopt to measure adequacy. They include:

(i) Post-retirement income as a proportion of pre-retirement income (typically referred to as a replacement rate);

(ii) Income in retirement should be at least at a level deemed necessary to attain an acceptable minimum standard of living (an absolute poverty line approach);

(iii) Income in retirement should be no lower than say 60 percent of the median income of some reference group of retirees (a relative poverty line approach);

(iv) Incomes in retirement should be at least equal to some fraction of the average pre-retirement incomes of the current working population (a variant of a relative measure);

(v) Incomes in retirement should be at a level that people can sustain their pre-retirement level of consumption thereby avoiding a drop in their living standards (a consumption smoothing approach);

(vi) Incomes in retirement should be such that it permits an individual to have the same marginal utility of consumption over time (ie, the last unit of consumption has the same value to the individual before and after retirement).

There are undoubtedly other measures that could be proposed. For example once uncertainty is allowed, then we can ask whether an “adequate” retirement income is one which would be capable of covering any possible eventuality, such as unanticipated health expenses, or extended life expectancy. Or should it cover say 80% of the expected costs of such occurrences? In the face of planning under uncertainty, one would want to consider the role of insurance markets to reduce the costs of uncertainty. In the absence of insurance instruments (either a private policy or a social programme that addresses emergency needs or catastrophic events), one might well expect the level of precautionary saving to be higher. In short, the level of uncertainty, an individual’s attitude to risk, the cultural patterns of extended family support, the labour force participation patterns of the retirees and the scope of private markets and social insurance would all shape what we might consider as an “adequate” level of retirement wealth. Adequacy cannot be determined without reference to the social and economic context.

Clearly, preferences differ widely and that factor alone can help explain a considerable amount of the variation in retirement accumulation across individuals. The fact that wealth is typically much more unevenly distributed than income is solid testimony to the fact that individuals, similar in all major observable aspects, will choose to accumulate different amounts, quite apart from the influence of any windfall gains or losses. Venti and Wise (2000) based on an analysis of households in the USA report:

…“at all levels of lifetime earnings there is an enormous dispersion in the accumulated wealth of families approaching retirement. We find that very little of this dispersion can be explained by chance differences in individual circumstances. We conclude that the bulk of the dispersion must be attributed to differences in the amount that households choose to save. The differences in saving choices among households with similar lifetime earnings lead to vastly different levels of asset accumulation by the time retirement age approaches”.

Some individuals will have a more risk averse attitude than others, while some will attach different probabilities to possible adverse events. These differences will influence the level of precautionary savings that we observe across individuals. Both the actual level of saving and the “adequate” level of saving will be the resolution of a complex set of factors involving the preferences and perceptions of individuals together with their health and capabilities, the public policies that are in place, and opportunities in labour markets. Any consideration of adequacy cannot be divorced from these influences.

We have chosen to approach the matter of retirement income and saving by asking what level of post-retirement income could individuals expect to have based on their current and projected wealth? We estimate the saving rates and the replacement rates that are implied if individuals attempt to sustain an equal level of consumption before and after retirement; ie, we invoke consumption smoothing as the aim of retirement saving. This approach has theoretical appeal and has been widely used in the literature. In addition we analyse the distribution of the predicted retirement incomes and calculate how many people would have incomes in retirement below 60% of the median income of that cohort (ie, a relative poverty line approach).

Housing wealth represents some particular challenges. In the first place we assume no real capital appreciation in housing values; they are simply assumed to remain constant in real terms. This is a conservative assumption that could understate projected retirement wealth. A somewhat typical pattern is for those owning a primary residence to retain this, partly as a precautionary investment and partly as a potential bequest. In such cases it would not be appropriate to include the net value of housing assets as part of retirement wealth and thereby available to be converted into an annuity along with other accumulated assets. In the empirical analysis we have excluded entirely the value of net worth in housing as a source of retirement income.[5]