What Accounts for the Variation in Retirement Wealth Among U.S. Households?

Abstract

Even among households with similar socioeconomic characteristics, saving and wealth vary considerably. Life-cycle models attribute this variation to dtfferences in time preference rates, risk tolerance, exposure to uncertainty, relative tastes for work and leisure at advanced ages, and income replacement rates. These factors have testable implications concerning the relation between accumulated wealth and the shape of the consumption projile. Using the Panel Study of Income Dynamics and the Consumer Expenditure Survey, weJind little support for these implications. The data are instead consistent with "rule of thumb," "mental accounting," or hyperbolic discounting theories of wealth accumulation. (JEL Dl, D91, E21)Wealth and saving vary considerably, even among households with similar socioeconomic characteristics (Steven Venti and David Wise, 1998;Annamaria Lusardi, 1999). The interpretation of this variation is a pivotal issue. If saving reflects rational, farsighted optimization, then low saving is simply an expression of preferences-saying that someone saves "too little" is comparable to asserting that he or she doesn't listen to enough classical music (Edward Lazear, 1994). If, however, households are shortsighted, boundedly rational, dynamically inconsistent, impulsive, or prone to regret, then the adequacy of saving is a well-posed and important empirical issue (B. Douglas Bernheim, 1995).Various factors could in principle account for NOTE: The reference numbering from the original has been maintained in this citation list.

The Retirement-Consumption Puzzle: Anticipated and Actual Declines in Spending at Retirement

“…1 Furthermore, the data themselves are less than ideal in that they are synthetic cohorts rather than true panel data. Bernheim, Skinner and Weinberg (2001) base their estimate of the drop in consumption on the change in food consumption, both at home and away from home, and on the implicit flow of housing services from owner-occupied housing and from rental housing. The total of these consumption items is inflated up to an estimated total by a factor derived from the ratio of these items to total consumption in the CEX.…”

“…However, British households apparently reduce consumption at the ages associated with retirement and the reduction cannot be explained by the life-cycle model (Banks, Blundell and Tanner, 1998). Households in the Panel Study of Income Dynamics sharply reduced several components of consumption at retirement (Bernheim, Skinner and Weinberg, 2001). The observed drop in consumption at retirement is the retirementconsumption puzzle.…”

Age Cohort Effect on Financial Planning Preparation

“…Another possible explanation for falling expenditure is that individuals are able to substitute leisure for consumption after they retire (Banks et al, 1998). Bernheim et al, (2001) show that the drop in consumption is much sharper for those households that arrive at retirement with little wealth . Individuals faced with reduced income following retirement are forced to reduce consumption.…”

“…Households entering retirement with inadequate savings must cut their consumption level, contrary to the life-cycle model predictions. Banks et al, (1998) report evidence of a consumption fall around retirement (the retirement consumption puzzle) for the UK; Bernheim et al, (2001) for the US; and Battistin et al, (2008) for Italy. Bernheim, Skinner and Weinberg (2001) provide evidence that individuals enter retirement with inadequate savings.…”

“…Banks et al, (1998) report evidence of a consumption fall around retirement (the retirement consumption puzzle) for the UK; Bernheim et al, (2001) for the US; and Battistin et al, (2008) for Italy. Bernheim, Skinner and Weinberg (2001) provide evidence that individuals enter retirement with inadequate savings. Smith (2006) stresses the importance of distinguishing between voluntary and involuntary retirement: a significant drop for food consumption is observed only for those who retire early because of poor health or job loss.…”