2.5.3 - ADEQUATE LEVEL OF INCOME

Many economists and policy-makers have expressed concern that households do not save enough to maintain an adequate standard of living during retirement. There is no consensus however, on what this standard should be or what level of saving is necessary to achieve it. In the literature, the optimum level falls somewhere between two standards of ‘adequacy’. The first is a widely accepted standard — having available retirement income of between about two thirds of pre-retirement earnings (regarded as the level necessary to maintain consumption levels prior to retirement). The second involves having retirement income equal to or greater than poverty or near poverty levels of income (Binswanger & Schunk 2009).

The question of what represents an adequate standard of living during retirement basically relates to a trade-off between spending during working life and spending during old age (Scholz & Seshadri 2008). One study, carried out in the US and the Netherlands, looked at the minimum level of retirement spending below which people would not want to fall and found that a majority of people in those countries aim to achieve in excess of 80 percent of working life spending (Binswanger & Schunk 2009).

Discussing the adequacy of a savings (as opposed to an insurance) model, Moore and Mitchell (1998) concluded that Americans are not preparing adequately for retirement. They found that a couple would need to save 20% of annual earnings to have a replacement rate of 61% and that a single woman would need to save around 32% of her income to have a replacement ratio of 54% at age of 62. They conclude that the majority of older households will not be able to maintain current levels of consumption into retirement without additional saving (Moore and Mitchell 1998).

An Italian study looked at the age pattern of spending on health, fuel, housing and food at home. It found that expenditure increased for all these items, up to age 70, and after the age of 70, an upward-sloping trend prevailed for both health and fuel (heat and electricity) while it declined respectively for food at home and housing services. The authors also (unsurprisingly) found evidence that consumption of work-related goods falls around retirement age and home production of food and other goods increases. They concluded that there is a fall of total consumption at retirement, which they estimated at 5.44%, which is in line with previous research in the UK and US (Miniaci and Monfardini, 2005).

An OECD study looked at what they described as ageing ‘puzzles’. They questioned the tendency for consumption to decrease during retirement which they felt contradicted the idea that households save in order to maintain their consumption level after retirement (de Freitas and Martins 2009). A number of studies have offered explanations for this drop in consumption. Hurd and Rohwedder (2003) argue that the drop in spending can be explained by the drop in work-related expenditures at retirement and market-purchased goods & services are substituted by home-produced goods, for example long-term care services, which often are provided informally within families. However, in a more recent paper, Hurd and Rohwedder (2006) argue, that factors such as leisure or poor health could also explain the decline in spending.

The issue of whether to respond to an expectation of longer healthy lives by working longer or saving more was addressed by Bloom, Canning and Moore who argued that it was a question of personal preference. If people work longer they can keep their consumption levels high and need only save at the same rate as before in anticipation of old age. Alternatively, if they decide to take extra leisure and retire at the same age as before they will have lower consumption levels throughout their life and will need higher savings rates while working (Bloom, Canning and Moore 2004 and 2007). They conclude that when health improves and longevity rises the best response is likely to be a longer working life, without the need for higher savings. To the extent that working lives lengthen in response to longer life spans there is no need for a reduction in income levels.

De Freitas and Martins raised the question of why an increase in longevity, resulting in an increase in the duration of retirement, did not result in an increase in the saving ratio. Bloom et al. (2003) argued that higher life expectancy should lead to an increase in savings, but research has often found the opposite occurs. More recently, Bloom et al. (2006) have shown that without a strong incentive to save for retirement, increases in longevity will not result in higher savings (Bloom et al 2006).

At an individual level, with increases in life expectancy, pension funds will need to provide income for a longer period of time. It is clearly unsustainable to fund pensions at the level people expect unless we save more or extend our working lives. The current trend is towards starting work at a later age so an extension of the working life will need to take place at the retirement end. Barr (2006) has quantified the effect in the UK; in 1950, 53.1 years of working life was expected to pay for 10.8 years of retirement but by 2004, 47.6 years of working life was expected to pay for 20.1 years of retirement. McCarthy (2009) concludes that if such figures were similar in Ireland, “something’s got to give.”

Generating a significant increase in personal retirement savings will also help to make PAYG pensions more sustainable. However, current saving reduces the level of current consumption and consequently there tends to be many reasons for people to delay providing for a pension. It has been suggested that a lack of financial literacy can lie at the heart of the problem. A study which examined the role consumer education and consumer advice on pensions can play in enhancing financial literacy, compared two case studies focused on Germany and the UK. It found that financial education with regard to old-age provision can be successful if it reaches consumers at life-stages where important decisions need to be made. The authors conclude that to achieve this considerable efforts have to be taken in terms of funding and organizational set-up (Binswanger & Schunk 2009).