Savings at the end of time

Once the effort to save is made, Americans retain surprisingly large amounts of assets until the end of their lives

Christian Gressner

When it comes to the end of time, rational economic beings should have little left, unless they want to bequeath wealth to later generations. Or so economic theory has it.

Yet the reality is different. Roughly a third of Americans own $250,000 or more in non-annuitized wealth when they arrive at the end of their lives, according to a recent paper by James Poterba (Massachusetts Institute of Technology). Examining two groups – those aged 51 to 61 and those 70 or older in, and following them until – for their paper What Determines End-of-Life Assets?, Poterba and colleagues Steven Venti (Dartmouth College) and David Wise (Harvard University) found that asset levels are persistent over the retirement phase. For the fortunate ones with substantial assets, this means they hardly spend down during their time in retirement. Asset levels are equally persistent at the lower end of the wealth distribution. Some 70% of the younger cohort who ended their life with less than $50,000 of assets also began retirement with similarly low levels. The same is true for 52% of the older group.

The authors conclude that total non-annuity wealth (real estate, business and financial assets) often hardly declines in later life unless the retiree falls seriously ill – that is, suffers from a stroke or chronic illness. “Our research shows that low wealth at the end of life often is an issue of low saving, not over-spending,” Poterba, also president of the National Bureau of Economic Research (NBER), says. Examining motivation such as the desire to leave a bequest was outside the scope of this study.

SAVING BECOMES MORE DIFFICULT

The challenge of an adequate retirement income looms even larger in the current low-interest-rate environment. “The way defined contribution plans interact with current financial market conditions is a nontrivial challenge,” Poterba says as in an interview with PROJECT M.

Our research shows that low wealth at the end of life often is an issue of low saving, not over-spending

Assuming inflation-adjusted investment returns of 2% per year and 1% annual inflation-adjusted wage growth, a worker would have to save almost 15% of each paycheck for 40 years to receive an annuity stream equal to half of his earnings at just before retirement. Saving for only 20 years one would need to set aside more than a third of earnings, Poterba calculates in Retirement Security in an Aging Population. In reality, actual household saving rates in the US are around 7%.

When asked whom he pities more – the pension reformer set against the twin challenges of sustainability and adequacy, or the worker struggling to save more – Poterba is too much of an academic to provide simple answers. Intent on understanding what drives wealth accumulation and retirement spending, he carefully weighs his response. “Both have to work through a challenging environment.”

On second thought, Poterba becomes controversial in his own quiet way, hinting that the debate over sustainability might involve too much hysteria. “There is not much deep economics in the sustainability discussion. Given a country’s demographic facts, its retirement age and wage level, sustainability comes down to ‘what goes in can come out.’” Poterba expects unsustainable public pensions to be reformed by a combination of higher taxes and higher contributions as well as an increased retirement age.

Working longer can be a particularly powerful tool as the years between 55 and 64 are often high-saving years – with the kids out the house and the mortgage largely paid back. Coincidentally, working longer also reduces the ratio of accumulated assets to time spent in retirement. Reducing retirement by three years can increase the monthly budget available for consumption by 15%, according to Poterba’s calculations.

UNDERSTANDING POLICY IMPLICATIONS

To advance economists’ understanding of the saving and spending process, Poterba now seeks to combine the facts of real life with the insights of behavioral economists as well as intergenerational motives for saving. “The three saving motives – consumption over the life cycle, precautionary savings and bequests – all need to be put together in a model, which needs to be verified against behavioral economists’ insights. One thing that has emerged from research over the past decade is that precautionary considerations – the idea of saving now to have money in the case of unemployment or health shocks later – play a significant role for retirees who conserve their wealth in later life.”

The question what savers intend to do with their assets has vexed economists for more than two decades. The precautionary motive may be stronger for younger households with next to no rainy-day funds. On the other hand, much of the saving is done by wealthy households who are unlikely to need precautionary funds, Martin Browning and Annamaria Lusardi wrote in their contribution to the Journal of Economic Literature, “Household Saving: Micro Theories and Micro Facts.”

“Our reading of the evidence is that while the precautionary motive is important for some people at some times, it is unlikely to be so for most people,” they conclude on the basis of their literature review.

Apart from academic interest, there is also a policy element in Poterba’s work: “In the US, Social Security income bulks very large as a fraction of income for elderly households in the bottom third, maybe even the bottom half of the income distribution.” Policy changes in this area affect the key income source for this group, particularly as the canonical three-legged stool of retirement income – public and occupational pensions as well as private savings – is often a one-legged stool for lower income groups. “Understanding the late-life behavior of households is crucial for policymakers,” Poterba concludes.

Savings at the end of time

Once the effort to save is made, Americans retain surprisingly large amounts of assets until the end of their lives

Christian Gressner

Savings at the end of time

Once the effort to save is made, Americans retain surprisingly large amounts of assets until the end of their lives

Christian Gressner

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