Much of the disagreement over whether the United States faces a retirement savings crisis hinges on different assumptions on how household consumption changes once the kids leave home.
“Optimal savings” studies, which assume that household consumption declines and savings increase when the kids leave, suggest that most people are saving optimally. On the other hand, studies based on the assumption of steady consumption over the working years conclude that many households will end up underprepared for retirement.
Andrew Biggs and I teamed up with our colleague Angie Chen to get at the bottom of this issue. You should know that we each have skin in this game. I think that people are woefully unprepared for retirement; Andrew not so much. If we find a meaningful increase in saving when kids leave, he may be right; no increase in saving, then I win.
Researchers have tried to determine empirically which of these two theories better describes actual household behavior. As part of that effort, Andrew has a study that found parents reduce consumption at ages when their kids would be expected to be independent, which in theory would allow them to save more for retirement. We have found, however, that, using tax data, 401(k) contributions – the major way people save – do not increase in a meaningful way. If households are both consuming less but not saving more after the kids leave, where are the resources going?
In our recent joint study, we considered three possible explanations for these seemingly inconsistent results.
We could be defining savings too narrowly: Although parents do not increase their 401(k) contributions, they could be increasing their total saving if they are paying off their mortgage or other debt.
We could be defining consumption too narrowly: Studies using consumption surveys would miss any continued financial expenditures, such as parents helping with their kids’ rent, paying off student debt, or providing a down payment for a house.
We have not adequately considered what may be happening to income after the kids leave; parents may be adjusting their labor supply and earnings.
Here’s what we found using data from the Health and Retirement Study and the Panel Study of Income Dynamics.
In terms of saving, we found no evidence that parents were increasing their monthly mortgage payments, making large one-shot contributions to reduce their mortgage, or paying down mortgage debt. Thus, the conclusion that parents aren’t increasing their savings when the kids leave seems right.
In terms of consumption, parents do not appear to provide continued support to their kids once they leave home, nor do they expand support to any other family members. Hence, the story that parents reduce consumption once the kids leave also seems right.
Our findings with regard to income provide some explanation for how consumption can decrease and savings not increase. Specifically, we found that parents are in fact working less and earning about $2,500 less per year after their children become independent
The implications of lower earnings and lower consumption on retirement savings depend on how much parents reduce consumption relative to income. The results show that consumption relative to income decreases by 3% to 6% after children leave. However, this reduction in consumption does not translate into higher net worth. So, once again, the question of where do the resources go remains.
So, neither Andrew nor I can declare victory. But, thanks to Angie, I think we moved the ball forward by identifying the change in income as a factor contributing to the seemingly contradictory results.