Do Households Increase Their Savings When the Kids Leave Home?

Much of the disagreement over whether households are adequately prepared for retirement reflects differences in assumptions regarding the extent to which consumption declines when the kids leave home. If consumption declines substantially when the kids leave home, as some life-cycle models of retirement saving assume, households need to achieve lower replacement rates in retirement and need to accumulate less wealth. Using administrative tax data from the Health and Retirement Study (HRS), as well as the Survey of Income and Program Participation (SIPP), this paper investigates whether household consumption declines when kids leave the home and, if so, by how much. Because consumption data are noisy and savings is the flip side of consumption, this paper examines whether savings in 401(k) plans increase when the kids leave home. The paper also investigates alternative methods of saving, including non401(k) savings and increased mortgage payments. This paper found that: • Households increase contributions to 401(k) plans by 0.3-0.7 percentage points when the kids leave home. • The finding is significant across datasets and for alternative definitions of the kids leaving home. • The increase in 401(k) contributions, however, is only a fraction of that predicted by lifecycle models that assume consumption declines substantially when the kids leave. • Home-owning households whose kids leave home are also less likely to have a mortgage than other households – suggesting higher post-kid payments – but the amount of increased savings implied is again much smaller than predicted by the life-cycle model. The policy implications of this paper are: • Most households will not be able to maintain their pre-retirement standard of living. • Retirement saving needs to increase. Introduction Academic opinion differs as to whether the United States faces a retirement savings crisis. Some researchers argue that only half of households will be able to maintain their customary spending level in retirement (Mitchell and Moore 1998, Munnell, Orlova, and Webb 2013). Others argue that maintaining consumption is an overly ambitious and indeed suboptimal goal. Drawing on economic theory, they contend that households should set a goal, not of smoothing consumption, but of smoothing the marginal utility of consumption. If consumption needs, and thus the marginal utility of consumption, are higher while the kids are at home, then households should optimally plan for higher consumption then and lower consumption after the kids leave home and in retirement (Scholz and Seshadri, 2006, 2008). An important corollary of lower consumption when the kids leave home is that most retirement savings will take place just before retirement. The two theories presented above have very different implications for whether or not we face a retirement savings crisis. If savings spike after the kids leave home, we likely do not face a widespread retirement saving crisis. But if households do not increase savings, many will arrive at retirement with insufficient resources to maintain the higher per capita standard of living they became accustomed to after the kids left. The question is which of these two possibilities best describes household behavior? To answer this question, this paper uses data from the Health and Retirement Study (HRS) linked to W-2 tax records to examine whether 401(k) contributions spike when the kids leave home. The analysis is conducted both in the pooled cross section, i.e., comparing similar households that differ as to whether the kids have left, and using fixed effects, i.e., comparing 401(k) savings for the same household before and after the kids leave. Because some households will support non-resident kids while they are in school, we use various definitions of the kids leaving home, some of which consider college students as still present. For the majority of households that save little outside of their 401(k), the W-2 tax records yield a highly accurate measure of total saving in financial assets. But, of course, not all saving is conducted through 401(k)s, so this paper also investigates the effect of the kids leaving on non-401(k) wealth and mortgage payments. Another concern is that the HRS contains households where the head is age 50 or older, and therefore the results may not reflect the behavior of the broader population. We therefore supplement the HRS analysis of 401(k) contributions with a pooled-cross-section