June 27, 2011

Wages, Retirement and Life Expectancy: If We’re Living Longer, Why Are We Saving Less?

A new academic study on the effect of increased lifespans on savings rates confirms old suspicions and raises some interesting new questions.

The conclusions reached by Optimal Retirement and Saving with Increasing Longevity, by David E. Bloom, David Canning, and Michael Moore are simple enough but need some unpacking: “[A] higher level of wages leads to earlier retirement and increasing savings rates. On the other hand an increase in life expectancy leads to an increase [in] the retirement age, but less than proportionately, while reducing savings rates.”

The Effect of Wages on Retirement Age

First, the idea that a higher level of wages leads to earlier retirement and increased savings is not entirely unexpected. People with more resources are more likely to have greater disposable income. And although it’s not always the case, higher-income individuals tend to receive a better financial education and are more keenly aware of the need to save for the future.

This result emphasizes the importance of planning for middle-income families. Without a solid plan, many will be stuck working many more years than they hoped or planned. The difficulty for these underserved families is that advice from financial professionals is often outside their means. And without advice, retirement is often a secondary concern that’s left to fate. 

The Effect of Life Expectancy on Savings Rates

The study’s second conclusion is less intuitive. It found that an increase in life expectancy tends

to correlate with reduced savings rates. In other words, people are saving less as a percentage of income as they live longer. This result gives us some insight into the psychology of saving.

Worldwide life expectancies have more than doubled in the last hundred years. While that’s cause to celebrate for human beings as a whole, it’s also raised a host of problems that didn’t plague people who expected to live only 30 years. We might expect that savings rates—savings as a percentage of income—would increase as life expectancy increases. After all, an increased life expectancy increases our need for savings, so we would hope that fact would motivate rational human beings to save more.

But that doesn’t appear to be the case. The study’s authors attribute the reduced savings rates to the effect of an increased life expectancy on consumption patterns. Increased life expectancies have had a drastic effect on “the awards of working and saving,” tending to increase our consumption and leisure time—and consequently reduce savings rates.

So how do you convince your clients to play less and save more when their on-time retirement is at stake?There’s no easy answer to the question. You’re working against instinct born from days when humans didn’t need to worry about having a long and healthy life. Emphasize the fundamental rewards of increased savings: a secure, stress-free retirement with lots of leisure time.

For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s partner, AdvisorFX, for a free trial.

See also The Law Professor's blog at AdvisorFYI.

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