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.”

	Mid-Career Households Spent More than Older Households, and Spending Patterns Varied by Expenditure and Income Level

		Older Households Spent about 20 Percent Less than Mid-Career Households in 2013

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. Such fluctuations in spending have implications for the resources  households will need to maintain their standard of living. Housing Was the Top Expense Regardless of Age, and Older Households Spent More Out-of-Pocket on Health Care

While the share of spending was relatively consistent across age groups  in some categories, there were larger variations by age for other  categories. 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. Spending, Household Characteristics, and Earnings Are Key Factors Used by Researchers and Financial Professionals to Develop Target Replacement Rates

		Changes in Spending Are Important to Account for When Deciding How Much Income Should Be Replaced in Retirement

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. For example, retirees may be in  a lower tax bracket after retirement. Two options cited by the articles  and reports in our review are final average earnings and average  earnings over the course of a career. Some Financial Professionals Recommend Target Replacement Rates While Others Question Their Usefulness

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. 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. Among EBSA’s retirement  planning publications is one that is intended to help younger workers  understand how much they need to save for retirement. 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. 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. Additionally, DOL’s tools do not provide  flexibility to allow a user to customize or compare rates. Recommendations for Executive Action

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. In its written comments, DOL generally agreed with our findings and  recommendations. 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. Appendix I: Objectives, Scope, and Methodology

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 was the most  recently available data at the time of our review. The survey data are collected for the Bureau of Labor  Statistics (BLS) by the U.S. Census Bureau. To determine which firms  to contact, we relied on suggestions from several researchers and  actuaries who have studied replacement rates. Appendix IV: Other Factors That Could Inform Target Replacement Rates

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. Further, LTC service rates can be  expensive. What Workers Need to Know about Social  Security as They Plan for Retirement. Replacement  Rates for Retirees: What Makes Sense for Planning and Evaluation?
Why GAO Did This Study

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.

What GAO Found

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.

What GAO Recommends

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.