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Can Low Retirement Savings Be Rationalized?

Jason Scott, John B. Shoven, Sita N. Slavov and John G. Watson
The Journal of Retirement Spring 2021, jor.2021.1.082; DOI: https://doi.org/10.3905/jor.2021.1.082
Jason Scott
is a managing director at J.S. Retirement Consulting in Los Gatos, CA
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John B. Shoven
is the Charles R. Schwab Professor of Economics at Stanford University in Stanford, CA
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Sita N. Slavov
is a Professor of Public Policy at George Mason University in Arlington, VA
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John G. Watson
is a lecturer in Finance at the Stanford Graduate School of Business in Stanford, CA
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Abstract

Simple presentations of the life cycle model often suggest a constant level of real consumption in retirement. Similarly, financial planners commonly suggest that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working. However, constant consumption with age is only optimal under the precise and unlikely condition that the subjective rate of time preference is equal to the real interest rate. Most people exhibit a positive rate of pure time preference, and additionally discount the future by both mortality and morbidity risks. In comparison, the real interest rate is roughly 0%—and the term structure of interest rates suggests this condition is likely to persist. These considerations suggest that optimal consumption in the life cycle model declines with age.

This finding has major implications for optimal retirement saving. For instance, we find that for many, perhaps most, people in the bottom half of the lifetime earnings distribution, it is optimal to spend out their retirement wealth well before death and to live on Social Security alone after that. Very low earners may find it optimal to not engage in retirement saving at all.

TOPICS: Long-term/retirement investing, portfolio theory

Key Findings

  • ▪ Under plausible assumptions, optimal consumption in the life cycle model declines with age.

  • ▪ For many people in the bottom half of the lifetime earnings distribution, it is optimal to spend out retirement wealth well before death and live on Social Security alone after that.

  • ▪ These results stand in contrast to standard financial planning advice that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working.

  • © 2021 Pageant Media Ltd
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The Journal of Retirement: 10 (1)
The Journal of Retirement
Vol. 10, Issue 1
Summer 2022
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Can Low Retirement Savings Be Rationalized?
Jason Scott, John B. Shoven, Sita N. Slavov, John G. Watson
The Journal of Retirement Feb 2021, jor.2021.1.082; DOI: 10.3905/jor.2021.1.082

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Can Low Retirement Savings Be Rationalized?
Jason Scott, John B. Shoven, Sita N. Slavov, John G. Watson
The Journal of Retirement Feb 2021, jor.2021.1.082; DOI: 10.3905/jor.2021.1.082
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  • Article
    • Abstract
    • LITERATURE ON OPTIMAL CONSUMPTION PATHS
    • STANDARD LIFE-CYCLE MODEL AND CONSUMPTION TRAJECTORIES
    • DECLINING CONSUMPTION AND OPTIMAL RETIREMENT SAVINGS
    • DELAYING SOCIAL SECURITY, ANNUITY DEMAND, AND TIME DISCOUNTING
    • CONCLUSIONS
    • ACKNOWLEDGMENT
    • ENDNOTES
    • REFERENCES
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