Contrary to what financial theory predicts, new research from Europe shows that the elderly accumulate assets later in life than expected, likely because they want to leave bequests, are receiving pensions, or are reluctant to part with assets such as their homes.
The central tenet of the life-cycle hypothesis of Modigliani and Brumberg is that when people are young, they work, earn income and save (accumulate wealth) in order to prepare for living expenses during retirement. When people are old, they retire and finance their living expenses by dissaving (decumulating their previously accumulated wealth). However, bequest motives and precautionary saving arising from longevity risk and uncertain future medical and long-term care expenses impact actual spending – uncertainty means that even in the absence of bequeath motives, we cannot precisely exhaust wealth at the time of death.
Examining whether the retired elderly decumulate their wealth and whether their wealth accumulation (saving) behavior is influenced by bequest motives, precautionary saving and public pension arrangements are tests of the validity of the life-cycle hypothesis. Charles Yuji Horioka and Luigi Ventura, authors of the September 2022 study, “Do the Retired Elderly in Europe Decumulate Their Wealth? The Importance of Bequest Motives, Precautionary Savings, Public Pensions, and Homeownership,” used microdata on a large number of European countries from the Survey of Health, Ageing and Retirement in Europe (SHARE) to examine the wealth accumulation (saving) behavior of the retired elderly. They confined their sample to only single-person or couple households in which both the husband and wife were 60 or older and retired because the authors wanted to avoid the problem of having to allocate saving, wealth, etc., to cohabiting household members and because the life-cycle hypothesis predicts not that all elderly will decumulate their wealth, only that the retired elderly will. They also confined their sample to households with at least one non-cohabiting child because they were interested in looking at the impact of bequest intentions on wealth accumulation (saving) behavior – respondents with no living children are likely to have a weaker bequest motive, driven by different motivations.
The authors’ data source did not include any elderly who lived in nursing homes, so they were not able to include them in their analysis. The elderly who lived in nursing homes were more likely to be decumulating their wealth because of the high cost of nursing homes. Thus, excluding them from the analysis may have biased their conclusions. Following is a summary of their findings:
- Less than half (43.9%) of the retired elderly in Europe were decumulating their wealth.
- The average wealth accumulation rate of the retired elderly in Europe was positive, though relatively moderate (6.6% over a three-year period).
- Bequest motives were quite strong in Europe, with 90.4% of households planning to leave a bequest – 21.5% of households planned to leave a bequest of less than 50,000 euros; 21.8% planned to leave a bequest of 50,000 euros or more but less than 150,000 euros; and 47.1% planned to leave a bequest of 150,000 euros or more.
- Those with bequest intentions were more likely to accumulate wealth and showed higher wealth accumulation rates than others – the retired elderly who were not planning to leave any bequests at all or were planning to leave only small bequests were decumulating their wealth, with wealth accumulation rates of -12.0% and -3.0%, respectively. The implication is that the tendency of the retired elderly 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.
- There was only limited evidence that precautionary saving arising from longevity risk and uncertain future medical and long-term care expenses was important as an explanation for the tendency of the retired elderly to not decumulate their wealth at all or to decumulate their wealth more slowly than expected.
- Generous public pension systems helped explain the existence of the “wealth decumulation puzzle” in Europe.
- The reluctance of retired elderly homeowners to sell or borrow against their owner-occupied housing was another contributing factor to the puzzle.
- A serious or chronic health condition was found not to have a significant impact on the probability of accumulating wealth.
- The probability of accumulating wealth decreased with age until 78.
- Marital status did not have a significant impact on the probability of accumulating wealth.
- Wealth had a significantly negative impact on the probability of accumulating wealth.
- Neither the number of children, gender nor educational attainment had a significant impact on the wealth accumulation rate.
- The wealth accumulation rates of homeowners were much higher than those of renters (13.4% vs. -2.4%), and renters were moderately decumulating their wealth on average.
One counterintuitive finding was that the expectation of living longer than another 10 years had a negative and significant impact on the probability of accumulating wealth, with the estimated marginal effect implying that the retired elderly who expected to live a long life were 6.3 percentage points less likely to accumulate wealth than other retired elderly. Intuitively, an individual expecting to live a long life would be more likely to continue accumulating wealth. Horioka and Ventura hypothesized that those expecting to live for a long time are more likely to decumulate their wealth because they are healthier than others and therefore more likely to engage in travel and other leisure-related consumption.
Another counterintuitive finding was that while public pensions provide insurance against longevity risk because of which there is less need for precautionary saving in countries with relatively generous public pension benefits (as is the case in most of Europe), the average pension replacement ratio had a significantly positive impact on the wealth accumulation rate.
A third counterintuitive finding was that being a strong risk lover had a significantly positive impact on the probability of accumulating wealth – a risk lover would be less worried about running out of wealth before passing away and hence less likely to continue accumulating wealth. A possible explanation is that risk lovers would likely have higher equity allocations, providing higher expected returns, leading to the wealth accumulation finding.
Taken together, these three findings suggest that precautionary saving is not an important determinant of whether the retired elderly continue accumulating wealth.
Their findings led Horioka and Ventura to conclude: “The Wealth Decumulation (or Retirement Saving) Puzzle (the tendency of the retired elderly to not decumulate their wealth or 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.” They added that “bequest motives, generous public pension systems, and the reluctance of retired elderly homeowners to sell or borrow against their owner-occupied housing are the primary explanations for the existence of the Wealth Decumulation Puzzle in Europe.”
For investment advisors, Horioka and Ventura’s findings provide interesting insights into retiree behavior, helping advisors understand how retirees think about spending and accumulating wealth, enabling them to ask questions and to educate retirees on the implications of their decisions. Retirees and those planning for retirement can also benefit from the behavioral findings and ensure they consider all the issues from the research.
Larry Swedroe is the head of financial and economic research for Buckingham Wealth Partners.
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