[DongleDongle] "Son Richer Than Dad"... The Robust Pension Accounts of US MZ Generation

MZ Generation Pension Income Replacement Rate 60%
Key to Success: Joining 401K Immediately After Employment
Efficient Pension Management with Default Options

Recently, the United States has seen the baby boomer generation (born 1946?1964), which has fallen into poverty, emerge as a significant social issue. As pensions have failed to keep pace with rising housing prices, the proportion of middle-aged and elderly homeless people has rapidly increased, especially in major cities like Florida and New York City.

American baby boomers are considered a generation that has relatively lagged behind other age groups in asset accumulation. During their childhood in the 1970s, they experienced the oil crisis; in their 30s during the 2000s, they went through the dot-com bubble burst and the Nasdaq crash. In their 40s, the 2008 global financial crisis struck. After reaching their 60s, many were laid off from part-time jobs they took after retirement due to COVID-19.

In contrast, the MZ generation (born early 1980s to early 2000s), who grew up witnessing the hardships of the baby boomers, is taking a better path in preparing for retirement. Major U.S. media outlets predict that this generation will receive pensions at levels similar to their working income even after retirement. Today, we will explore how efficiently the MZ generation in the U.S. is preparing for retirement.

[Image source=Getty Images Bank]

MZ Generation’s Pension Income Replacement Rate at 60%... Surpassing Baby Boomers and Generation X

Vanguard, a major U.S. asset management firm, analyzed that the MZ generation in the U.S. will receive pensions averaging about 60% of their working monthly income in the future.

Looking at income levels, the top 5% of the MZ generation, with an average monthly income of $173,000, have a pension income replacement rate of 85%. This means their pension will amount to 85% of the average income they earned during their pension enrollment period. They can cover living expenses with an amount similar to their working salary. In contrast, the preceding generations, Generation X (born early 1970s to early 1980s) and baby boomers, have pension income replacement rates of only 75% and 63%, respectively.

Even in the top 40% and 50% income brackets, the MZ generation’s income replacement rates reach 66% and 58%, respectively. In these brackets, Generation X and baby boomers have pension income replacement rates limited to 50%.

Early 401K Enrollment is the Key... Lack of Retirement Fund Knowledge Leads to Following Company Recommendations

Why were the MZ generation able to prepare more and faster retirement funds than other generations? The financial sector analyzes that the MZ generation’s earlier enrollment in 401K plans was the reason they could efficiently accumulate retirement funds.

[Image source=Bloomberg]

401K refers to a pension product similar to Korea’s defined contribution (DC) retirement pension products with default options tailored to individual investment preferences. In a 401K, employees and employers contribute a certain amount monthly to a retirement account with tax benefits within a set limit, and the employee directly manages the investments and bears the investment results. Most Americans invest these assets in stock funds or target-date funds (TDFs) that adjust the ratio of stocks and bonds. Employees can withdraw retirement funds after retirement at a lower income tax rate.

Another way Americans cover retirement funds is through Social Security pensions. Social Security is a system similar to Korea’s National Pension, where paying taxes on income for 10 years allows early retirement pension receipt starting at age 62. However, since it is difficult to cover living expenses with Social Security alone, Americans actively utilize the 401K system.

The MZ generation often enrolls in 401K plans as soon as they start working, following company recommendations. Since the 2006 amendment of the Pension Protection Act, all employees in the U.S. are automatically enrolled in 401K plans. Employees can opt out if they wish, but few MZ generation members express the intention to withdraw, so many maintain their 401K plans.

The Wall Street Journal (WSJ) analyzed that the MZ generation’s relatively limited understanding of retirement systems compared to other generations led them to continue with 401K plans. Having not received sufficient financial education by the time of college graduation, the MZ generation finds it difficult to evaluate various retirement fund options. Instead, they are satisfied managing their retirement funds through 401K as recommended by their companies.

Default Options and Automatic Contribution Systems Provide Mechanisms to Grow Pensions

Early enrollment in 401K is expected to bring significant benefits to the MZ generation in the distant future. Especially, the 'default option' (pre-designated management system) and the 'automatic escalation system,' introduced after the 2006 Pension Protection Act amendment, are expected to help grow the retirement funds accumulated by the MZ generation.

[Image source=Bloomberg]

The automatic escalation system refers to a plan where the contribution rate increases as the employee’s salary rises. The default option is a system where, if the participant does not manage their retirement funds for a certain period, the funds are invested in financial products provided by the employer. In other words, as wages increase, the retirement contribution rate also rises, and mechanisms are in place to ensure these assets are not neglected but continue to grow.

On the other hand, WSJ explains that baby boomers and Generation X, who started working before the introduction of automatic 401K enrollment, tend to have lower enrollment rates.

In real estate, including housing, the MZ generation still holds fewer assets compared to baby boomers and Generation X. Many voices point out that the burden of student loan debt makes it harder for the MZ generation to accumulate assets compared to other generations.

However, as reports emerge of increasing numbers of baby boomers unable to cover rent and other expenses due to insufficient pensions, the high pension income replacement rate of the MZ generation is noteworthy. Perhaps Korean MZ generation members should carefully observe the situation in the U.S. as well?