Work-to-retirement ratio

January 17, 2007

Free Market Foundation

Alex Pollock, a resident fellow at the American Enterprise Institute, suggests a simple tool for thinking about retirement savings: the work-to-retirement ratio.

Let’s say a worker today enters the work force at age 22 and stays until age 62, for a 40-year working life:

If he lives to 82, he will need to finance 20 years of retirement; thus, the work-to-retirement ratio is 40 years divided by 20 years, or 2:1.

In the 1880s, when German Chancellor Otto von Bismarck instituted the first state-run retirement programme, the typical ratio stood at a far more favourable 27:1.

The smaller the ratio, the more of your current income you have to save.

Given reasonable assumptions about wage growth, income needed in retirement and investment performance, a typical worker today must save 14 per cent of pre-tax income to finance retirement. The current savings rate is negative 0.5 per cent; that is, Americans are spending more than they earn, rather than saving, says Pollock.

Source: Work-to-Retirement Ratio, The American, November/December 2006; based upon: Alex J. Pollock, Retirement Finance: Old Ideas, New Reality, American Enterprise Institute, Financial Services Outlook, September 25, 2006.

For AEI study: http://www.aei.org/publications/pubID.24940/pub_detail.asp

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 09 January 2007