The central tenet of the life-cycle hypothesis is that, when people are young, they work, earn income, and save part of their income (accumulate wealth) in order to prepare for living expenses during retirement and that, when people are older, they retire and finance their living expenses by dissaving (decumulating their previously accumulated wealth). Thus, the life-cycle hypothesis or model predicts that older persons (especially retirees) should be decumulating their wealth. Moreover, it predicts that, in the absence of bequest motives and precautionary saving arising from longevity risk and uncertain future medical and long-term care expenses, they should be decumulating their wealth so as to precisely exhaust it at the time of death. Thus, examining whether or not retirees are decumulating their wealth and whether or not they are doing so at the expected rate are powerful tests of the validity of the life-cycle hypothesis or model.
Many researchers have analysed the wealth accumulation (saving) behaviour of older persons in various countries, and most of them have found that older persons (even retirees) continue to accumulate wealth (save) or that they decumulate their wealth (dissave) but that their rate of wealth decumulation is too slow to enable them to exhaust their wealth at the time of death. This puzzle has been called the 'wealth decumulation puzzle'.
Possible causes of the wealth decumulation puzzle
De Nardi et al. (2009, 2010) conduct an excellent survey of this literature, and as they point out, at least two explanations have been proposed for the wealth decumulation puzzle. The first explanation is that retirees are continuing to accumulate wealth or are decumulating their wealth (dissaving) more slowly than expected because they want to leave bequests and other intergenerational transfers to their children and other family members. The second explanation, which of course is not mutually exclusive with the first, is that they are continuing to accumulate wealth or are decumulating their wealth (dissaving) more slowly than expected because they are worried about longevity risk (lifespan uncertainty) and/or the possibility of facing high medical and long-term care expenses in the future. In this view, they are engaging in precautionary saving in response to these worries.
Virtually all previous studies find that both bequest motives and precautionary saving - arising from longevity risk (lifespan uncertainty) and/or the possibility of facing high medical and long-term care expenses in the future - play a role in explaining the wealth decumulation puzzle, but they differ greatly in the relative weight placed on these alternative explanations. For example, De Nardi et al. (2009, 2010, 2015, 2016) find that a significant part of the wealth decumulation puzzle in the US can be explained by health-related factors (viz. predictable and unpredictable variations in lifespans or out-of-pocket medical expenses), and Horioka et al. (1996), Horioka and Niimi (2017), and Niimi and Horioka (2019) obtain similar findings for Japan. By contrast, in Ventura and Horioka (2020) we find that bequest motives are more important than precautionary saving as an explanation of the puzzle in the case of Italy.
Our findings for Europe
In our recent paper (Horioka and Ventura 2022), we use micro data from a large number of European countries from the Survey of Health, Ageing and Retirement in Europe (SHARE) to examine the wealth accumulation (saving) behaviour of retired people aged 60 and over in Europe and to shed light on whether or not they are decumulating their wealth as predicted by the simple life-cycle hypothesis and on whether or not their wealth accumulation (saving) behaviour is influenced by bequest motives, precautionary saving, public pension arrangements, and homeownership. We are particularly interested in shedding light on whether or not the wealth decumulation puzzle applies in the case of Europe, and if so, what the explanation is for the puzzle.
To summarise our main findings, we find that less than half of these retirees in Europe are decumulating their wealth and that the average wealth accumulation rate of the retired elderly in Europe is positive though relatively moderate (6.6% over a 3-year period). These findings strongly suggest that the wealth decumulation puzzle (the tendency of the retired elderly to decumulate their wealth more slowly than expected) applies in the case of Europe, a finding that is consistent with the findings of previous studies for most countries.
Moreover, our regression analysis of the determinants of the wealth accumulation (saving) behaviour of the retired elderly in Europe suggests that those with bequest intentions are more likely to accumulate wealth and show higher wealth accumulation rates than others, which implies that the tendency of retirees to not decumulate their wealth at all or to decumulate their wealth more slowly than expected is attributable in large part to the presence of bequest motives. In fact, we find that the wealth accumulation rate of retirees would be negative if they were not saving in order to leave a bequest.
By contrast, we found only limited evidence that precautionary saving arising from longevity risk and uncertain future medical and long-term care expenses is important as an explanation of the tendency of retirees to not decumulate their wealth or to decumulate their wealth more slowly than expected. However, we do find that generous public pension systems help to explain the existence of the wealth decumulation puzzle in Europe. Finally, we did separate estimations for homeowner households and renter households and found that the wealth decumulation puzzle applies primarily to homeowners. This suggests that the reluctance of retiree homeowners to sell or borrow against their owner-occupied housing is one cause of the puzzle (Blundell et al. 2016a and 2016b, Nakajima and Telyukova 2019).
Thus, our tentative conclusion is that the wealth decumulation puzzle applies in Europe and that the tendency of Europeans to not decumulate their wealth at all or to decumulate their wealth more slowly than expected is due primarily to bequest motives and also partly to generous public pension systems and the reluctance of retiree homeowners to sell or borrow against their owner-occupied housing. Our finding that precautionary saving is not as important as it is in Japan and the US as an explanation of the wealth decumulation puzzle may be due to the fact that social safety nets are better developed in Europe, alleviating the need for precautionary saving.
Implications of our findings
We turn finally to the implications of our findings. First, our finding that the wealth accumulation rate of retirees is negative once we eliminate the impact of large bequests implies that the wealth accumulation (saving) behaviour of retirees in Europe is consistent with the life-cycle hypothesis or model once we take account of bequest motives and that it is appropriate to use this model when analysing household behaviour in the real world. Second, our finding that retirees in Europe are not decumulating their wealth, on average, implies that Europe’s household saving rate will not decline precipitously as the population ages. Third, our finding that bequest motives are the primary explanation for the failure of retirees in Europe to decumulate their wealth implies that we can stimulate their consumption by raising inheritance taxes, thereby possibly weakening their incentive to leave bequests. Fourth, our finding that public pension benefits alleviate the need for precautionary saving and increase the wealth decumulation rates of retirees suggests that increasing the generosity of public pension benefits will, for better or worse, stimulate the consumption and increase the wealth decumulation of older persons. Fifth, our finding that the wealth decumulation puzzle applies primarily to homeowner households suggests that increasing the availability of financial products such as home equity loans and reverse mortgages that allow retiree homeowners to borrow against their housing equity would also stimulate the consumption and increase the wealth decumulation of older persons.
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Nakajima, M and I M Telyukova (2019), “Home Equity in Retirement”, Federal Reserve Bank of Philadelphia, Working Paper.
Niimi, Y and C Y Horioka (2019), “The Wealth Decumulation Behavior of the Retired Elderly in Japan: The Relative Importance of Precautionary Saving and Bequest Motives”, Journal of the Japanese and International Economies 51: 52-63.
Ventura, L and C Y Horioka (2020), “The Wealth Decumulation Behavior of the Retired Elderly in Italy: The Importance of Bequest Motives and Precautionary Saving”, Review of Economics of the Household 18(3): 575-597.