Academic journal article Economic Perspectives

Asset Rundown after Retirement: The Importance of Rate of Return Shocks

Academic journal article Economic Perspectives

Asset Rundown after Retirement: The Importance of Rate of Return Shocks

Article excerpt

Introduction and summary

Do people run down their assets after retirement? This is an important question for a number of reasons. First, the elderly have a lot of wealth: Households with heads who are 65 years old and older have more than one-third of all U.S. household wealth. Given that the baby boomer cohort is approaching retirement age, this fraction will likely increase. Whether the baby boomers run down their wealth has important implications for all of us. Some have argued that when the boomers retire, they will run down their assets. They will wish to sell their assets, which will in turn drive down the price of assets. Poterba (2001) refers to this as the "asset market meltdown hypothesis." As Poterba points out, however, this depends critically upon how quickly the elderly actually run down their assets.

In this article, we provide evidence that households run down their assets after retirement. We track a group of elderly households over the 1996-2004 period, and find that assets for these households decline modestly over the sample period. However, the U.S. experienced a remarkable run-up in housing prices from 1996 through 2004. Thus, the fact that assets declined modestly does not mean that households planned to run down their assets modestly. Instead, it could be that households planned to run down their assets rapidly, but enjoyed high asset returns. Thus, using these measured asset profiles might give us a very misleading picture of what the baby boomers may do with their wealth. We find that, had there been no run-up in asset prices, assets would have declined substantially over the sample period.

Related literature and contributions of our article

The question of whether the elderly run down their assets has been debated at least since Modigliani and Ando (1957), in part because the answer to the question provides key insights as to why people save over the course of their lives.

There are two main reasons why the elderly maintain high levels of assets after retirement. First, the elderly presumably maintain assets to finance consumption after retirement. Furthermore, given that the elderly are presumably unsure of the age at which they will die and are unsure of the medical expenses they may incur after retirement, they must maintain additional assets to insure themselves against these risks. Second, the elderly may be slow to reduce their assets during retirement because they wish to bequeath some of their assets to their children, relatives, friends, or charities. Determining the extent of asset rundown during retirement is important for understanding whether these motivations are important.

Better understanding these savings motives will help us to better inform policymakers as to the likely effects of changing tax and transfer systems within the United States. For example, consider a policy issue where it is important to consider savings motives of individuals at the end of their lives: estate taxation. The estate tax is a tax on assets that remain after an individual dies and, for this reason, is sometimes called the "death tax." On July 7, 2001, President George W. Bush signed into law the Economic Growth and Tax Relief Reconciliation Act, which raised the estate tax exemption level and reduced the tax rate on estates starting in 2002. Before the Economic Growth and Tax Relief Reconciliation Act was passed, only estates valued over $675,000 were taxed. The exemption rose to $1,000,000 in 2002, then rose again to $1,500,000 in 2004, and is currently $2,000,000 (because the exemption level is per person, this translates into $4,000,000 per couple). Given the current $2,000,000 exemption level, only 0.5 percent of all estates are subject to the estate tax, according to the Urban-Brookings Tax Policy Center. Under current law, the estate tax exemption level will rise to $3,500,000 in 2009, and the estate tax will be completely repealed in the year 2010 and will be reinstated in 2011. …

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