Wealth Inequality May Not Be As Bad As You Think

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Social Security and private pension plans are a vital source of retirement income for millions of Americans as they enter their golden years. It turns out that they’re also an underappreciated variable that helps minimize wealth inequality.

A new paper published by the Federal Reserve Bank of Boston finds that once you account for people’s expected benefits from these sources of guaranteed income, America becomes a more equal place.

The authors of the study looked at Americans between the ages of 40 and 59, and they found that the share of wealth held by the top 5% declines from about 72% to 51% when wealth from private pensions and defined contribution plans like 401(k)s are added in. And it falls to 45% when you account for Social Security.

Of course, a large amount of wealth is still controlled by a few households at the top of the income scale. But soon-to-be retirees can take some comfort from the more equal world illustrated by this paper. You have a stronger handle on your future well-being than you might have been led to believe.

The Boston Fed Takes a Closer Look at Wealth Inequality

According to Jeffrey Thompson, the director of the Boston Fed’s New England Public Policy Center, the study aimed to make sure that people who are interested in wealth inequality have a full picture of what’s actually going on.

“A lot of my personal research has been focused on measurement issues, and the impact of how you measure things influences your understanding of this phenomenon,” said Thompson. “Part of the effort was to improve these measurements.”

Many studies of wealth inequality fail to take into account Social Security and private pensions, in large part because they’re not like other forms of wealth. A 43-year-old furloughed after economic lockdowns following the Covid-19 pandemic wouldn’t be able to tap their Social Security or private pension benefits, for instance.

Nevertheless, you can’t ignore these benefits when it comes to calculating wealth. For one thing, both sources of income will likely be there when folks actually retire, so you need to account for them in some way.

In addition, some households may use Social Security and private pension plans as a substitute for other types of savings, like individual retirement accounts (IRAs), for instance. This means that only measuring some forms of wealth and not others will not offer a complete picture of people’s overall financial well-being.

In this study the authors used data from the Federal Reserve’s Survey of Consumer Finances, along with some common-sense calculations and estimates, to help them build out a picture of the Social Security and pension wealth among those between the ages of 40 and 59, assuming that folks access their Social Security benefits as quickly as possible at age 62. That happens to be the most popular age to claim, and it also locks in the lowest monthly benefit.

The result was that once you included pensions and Social Security, along with employer-sponsored plans, income inequality started looking a lot less unequal.

“Among households with heads aged 40 to 49, the top 5%’s share of wealth excluding retirement plans and Social Security is 66%,” the paper noted. “Once these assets are included, the top 5%’s wealth share falls to 41%.”

Social Security and Private Pensions Matter

It turns out that these forms of wealth are a big deal for millions of Americans lower down on the income and wealth ladder.

Take someone in the 50th percentile of wealth. According to the paper, the mean household helmed by someone between the ages of 50 and 59 had a non-retirement net worth of $147,000 in 2019. But that pales in comparison to the amount they have in Social Security wealth ($295,000).

Once you include what they had in their 401(k)-type plan ($53,000) and a pension plan ($44,000), their wealth expands dramatically to $540,000.

“Including Social Security and retirement wealth in the wealth concept results in significantly lower top shares and less growth in the concentration of wealth,” the paper noted. “Social Security is very broadly held and has an equalizing effect; the top 5% held only 8% of this component in 2019.”

These results dovetail with the work from other researchers. For instance, the Boston College Center for Retirement Research used 2016 data from the Federal Reserve to break down the assets for a household smack-dab in the middle of the wealth distribution.

Social Security accounted for 60% of household wealth (almost $470,000) and pension plans counted for 17% ($134,000). While pension plans are much less prevalent now than they were in the 1980s, a durable portion of Americans—roughly 10% to 15%—have had some pension coverage since 2010.

The Role of Guaranteed Income in Retirement Wealth

The exact measurement of wealth inequality is surely an interesting academic question, but what does this have to do with you? After all, a change in measurement doesn’t directly impact how you’ll pay for the last third of your life when you stop working.

But retirement security isn’t entirely about dollars and cents. Much of your ability to craft, and then stick to, some kind of financial plan has to do with whether you believe you have control over your finances, a concept that Texas Tech assistant professor Sarah Asebedo refers to as financial self-efficacy.

You can also think about it as money grit.

No matter what you call it, one of the characteristics of someone with this trait is the belief that their behavior matters. One potential side effect of the wealth inequality debate is that many may feel that their particular bid for retirement security is hopeless. You’ll never be in the top 10%, much less the top 1%. If you’ll never be able to afford to retire, what difference does a little bit of extra savings make?

The research by the Boston Fed pours cold water on that nasty brand of cynicism. Yes, wealth inequality still exists, but you have more wealth than you realize, which means your future is brighter than you’ve been led to believe.

You can capitalize on that good news by redoubling your efforts to save for the future, which will only make your hold on your financial future even stronger.

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