Can Low Retirement Savings Be Rationalized?

37 Pages Posted: 2 Mar 2020 Last revised: 8 Mar 2021

See all articles by Jason Scott

Jason Scott

Independent

John B. Shoven

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Sita Slavov

George Mason University - School of Policy, Government, and International Affairs

John G. Watson

Stanford Graduate School of Business

Date Written: February 2020

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 zero percent and the term structure of interest rates suggests that 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.

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Suggested Citation

Scott, Jason and Shoven, John B. and Slavov, Sita and Watson, John G., Can Low Retirement Savings Be Rationalized? (February 2020). NBER Working Paper No. w26784, Available at SSRN: https://ssrn.com/abstract=3547134

John B. Shoven

Stanford University - Department of Economics ( email )

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Sita Slavov

George Mason University - School of Policy, Government, and International Affairs ( email )

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John G. Watson

Stanford Graduate School of Business ( email )

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