11 October 2023

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Pension: Elderly Individuals Do Not Decumulate Their Savings

Luigi Campopiano

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In theory, estate planning should work as follows (based on the life-cycle theory developed by the Italian Nobel laureate in economics, Franco Modigliani): individuals save money when their incomes are high, with the intention of using these savings when their incomes decrease. If everything goes as planned, this approach helps smooth abrupt changes in one's lifestyle that could occur when, upon reaching retirement, their incomes reduce. The reality, at least in Europe, doesn't necessarily follow this model; even in old age, many individuals do not spend the savings they have accumulated (in over 50% of cases, people continue to accumulate money).

According to the results published in a paper titled "Do Retired Europeans Decumulate Their Wealth? The Importance of Bequest Motives, Precautionary Saving, Public Pensions, and Homeownership," authored by two professors, Luigi Ventura (Professor of Economics at Sapienza University of Rome) and Chales Yuji Horioka (Professor at Kobe University), on average, Europeans do not decumulate but rather increase their savings by 6.6% over a three-year period, with less than half of them choosing to spend some of their savings. Why do elderly Europeans continue to save? Some of the answers are particularly interesting:

1. Limited impact of the longevity risk: The risk that an exceptionally long life could deplete savings, leaving them insufficient to fund the desired lifestyle or, worse, medical and long-term care expenses. However, according to data extracted from the "Survey of Health, Ageing and Retirement in Europe," the precautionary savings behavior is not significantly driven by this risk. The authors found only limited evidence that precautionary saving is due to the risk of longevity and uncertainty about future medical and long-term care expenses. The authors pointed out that when elderly individuals in Japan or the United States do not decumulate their savings, the influence of longevity risk and precautionary saving is more relevant, probably because social safety nets in Europe are better developed than in Japan or the USA.
2. Pension and homeownership matter: If elderly Europeans save even in old age, it's primarily for other reasons. This behavior is influenced by generous public pension systems and potential homeownership. The two economists argue that this explains why retired homeowners in Europe are reluctant to sell their homes or use them as collateral for loans.
3. The desire to pass on wealth to heirs: This is the most important factor behind the accumulation of savings by elderly Europeans. The economists discovered that the wealth accumulation rate of retirees would be negative (i.e., they would decumulate) if they were not saving to leave an inheritance to their heirs.

In conclusion, the authors believe that the prevalence of elderly individuals who are reluctant to decumulate their savings will not lead to an overall increase in the propensity to consume as the population continues to age. To reverse this trend, given that the desire to leave an inheritance to heirs is the predominant motivation for saving, consumption among the elderly could be stimulated by increasing inheritance taxes, thereby reducing the incentive to accumulate assets for the purpose of leaving an inheritance.