Many of us spend less money in retirement than economic theory says we should.
This theory – in the form of the lifecycle consumption hypothesis – says we should save during our prime working years and then run down our wealth after we retire.
But we don’t do this. Official figures show that in 2018-19 (the latest available data) 258,000 people died leaving total estates of £89.3bn. That’s an average of over £300,000 per person. And more than 46,000 people left more than £500,000.
Of course, some people are taken before their time. But this isn’t the whole story. Robert Holzmann at the Austrian Academy of Sciences and colleagues point out that, across Europe, richer people tend to build up their wealth in retirement rather than run it down.
It’s unlikely that they do so simply to leave bequests: even single people don’t run down their wealth to nothing. Nor is it because they save in anticipation of medical or social care bills later in life. Malene Kallestrup-Lamb at Aarhus University points out that even in Denmark – a country with an adequate welfare state – many retirees continue to save.
Something else, then, is going on.
One of these things is simply force of habit. It’s hard to break a decades-long habit of spending less than our income and seeing our wealth increase. Most of us, rightly, have a target level for our wealth – an amount we think we need to see us through retirement. But this target becomes a reference point and we feel uncomfortable seeing our wealth fall below it, just as we feel uncomfortable selling shares at lower prices than we bought at. This is especially the case if we make the unintended error of identifying with our wealth, of thinking of ourselves not as rich but as a rich person. If we do this, running down our portfolio becomes a threat to our identity.
There’s more. There’s also the same thing that causes people to spend too much in the summer for houses with swimming pools: we fail to see that our preferences will change.
The nasty truth is that for many of us there’ll come a time when we’re no longer so able to enjoy spending money: in the economic jargon, our marginal utility of consumption will fall. If our fitness fails us, we’ll no longer enjoy playing golf on expensive courses; failing eyesight will stop us driving nice cars; and if our mobility is impaired we’ll not enjoy going on holiday so much. And so we spend less in old age simply because we get less bang for our buck. Which in fact we do. Economists at the IFS have shown that, on average, 79-year-olds spend only half as much on non-durable goods and services as 45-year olds.
These falls in spending mean that we don’t run down our wealth in retirement.
Many of us have biased risk perceptions. We are alive to the risk that our wealth will be hit by a nasty bear market and so rein in our spending, but we under appreciate the risk that our spending will dwindle anyway later in life. And so we save too much.
Poor health, however, isn’t the only reason why we should spend more early in retirement and less later. There’s another. Quite simply, real interest rates are negative which means patience and saving are being punished. This isn’t a reason for everyone to spend more: if you are saving for a particular target, low returns mean you might need to save more. If your wealth is above target, however, it is a case for spending now rather than later – for giving in to temptation.
This is especially true because some spending is a form of investment. Itzhak Gilboa at the University of Tel Aviv points out that spending on holidays, days out or concerts builds up a stock of happy memories we can enjoy later. Such memories are in effect capital goods –things which yield a flow of services for years after we’ve bought them. Just as low interest rates should stimulate capital spending so too should they boost investments in memories.
All this means that those of us who have recently retired (as I will be by the time you read this) should relax about spending now. As that underrated economist Doris Day sang, “Enjoy yourself while you’re still in the pink”.
But it has other implications. If we don’t spend all our wealth in retirement then (unless we intended to leave a bequest) we have saved too much during our working life or worked too long. That, says Stanford University’s John Shoven, means many people in work should save less. It also means some should retire early – as indeed many are: ONS data show that the number of 50-64 year-olds who are economically inactive have risen by 280,000 (or 8.7 per cent) in the last two years.
We think of prudence as working hard and saving. But it is possible to be recklessly and irrationally prudent, and to work and save too much.
Of course, fund managers don’t like the idea of us saving less, and bosses don’t want us to drop out of the labour market. But then, their interests do sometimes conflict with those of ordinary people – and, in fact, with the advice of conventional economics too.