Household Income, Asset Allocation, and the Retirement Decision (original) (raw)

Financial Services Review, 2003

Abstract

Abstract We examine the financial condition of households as they move into retirement and the relative influence of wealth and income on the decision to retire. We find no significant difference between the net worth of retired and nonretired households, suggesting that retirees are no more adequately prepared for retirement than the nonretired subsample. With respect to portfolio allocation, retired households have significantly more financial assets, with a concentration in fixed-income securities, but home equity accounts for nearly half of their net worth. In addition, other household members' employment earnings generate approximately 40% of income for retired households. (C) 2003 Academy of Financial Services. All rights reserved. JEL classification: J26; D14; J14 Keywords: Retirement; Asset allocation; Wealth; Income; Probit 1. Introduction Within the area of personal finance, several trends have lent emphasis to the importance of individual retirement planning. Among those trends are the aging of the baby-boom generation, a general increase in average life expectancy, and the increasingly apparent burden that both of these issues are placing on the federal Social Security system. Indeed, while the future condition of Social Security is an issue of intense debate, there is general agreement that it will not continue in its current form (Tacchino and Saltzman, 2001; Fraser, Jennings and King, 2000). In addition, within private industry there has been consistent movement away from defined benefit retirement plans that are primarily created and administered by employers toward defined contribution plans that require more active employee participation (Bodie and Crane, 1999; Anthes and Most, 1999). The combination of these trends has placed increasing significance on an individual's responsibility to financially plan for his/her retirement years. In response to these trends, there is a growing body of literature addressing the financial issues of retirement. While the focus of studies has varied, a point of commonality among the literature to date has been the general lack of detailed retirement data. As a result, the majority of studies have been forward-looking, focusing on the process of preparing for retirement, but remaining fairly limited in what can be said once individuals actually reach retirement. The purpose of this study is to examine what is actually being done to financially prepare for retirement as compared to the theoretical and empirical arguments for what individuals should be doing. Specifically, we use four waves of the Health and Retirement Study (HRS) to analyze the financial condition of a sample of households as they move into retirement. We examine the allocation of assets, sources of income, and the adequacy of the preparation for retirement. We then test for the relative influence of these variables on the decision to retire. Note that while the retirement decision is likely to be significantly influenced by nonfinancial variables (e.g., health status, marital status, utility of leisure, etc.) as well, we leave these issues to be addressed in future research. The paper proceeds as follows. We provide a review of the relevant literature in Section 2, and an overview of our data and the methodology we employ in Section 3. We present our empirical results in Section 4 and conclude the paper in Section 5. 2. Literature review The retirement literature most related to this study is the research that examines the allocation of assets in preparation for retirement and the overall adequacy of financial assets to support retirement needs. Asset allocation studies consider the optimal mix of assets to be chosen in preparing for retirement. Retirement adequacy studies estimate the level of resources necessary to meet postretirement consumption needs, and based on these projections, assess the adequacy of preretirement preparation. …

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