CRR: Do Parents Live It Up When Children Fly the Coop?

* The authors are all with the Center for Retirement Research at Boston College. Norma B. Coe is associate director of research, Zhenya Karamcheva is a research associate, and Anthony Webb is a research economist.

Introduction

With the virtual disappearance of traditional pensions, declining Social Security replacement rates, and longer life spans, the retirement landscape is shifting dramatically. Today, responsibility for a comfortable retirement rests mostly on the individual. This change has led to widespread concern about the adequacy of households’ retirement savings.

Experts disagree on whether Americans are adequately prepared for retirement. A Center for Retirement Research (CRR) study conducted before the financial crisis estimated that 43 percent of households are ‘at risk’ of being unable to maintain their pre-retirement standard of living in retirement. 1 In contrast, another well-publicized study that compares optimal savings with that reported in the Health and Retirement Study (HRS) concluded that less than 4 percent of Americans are behind in their retirement saving.

The difference in the estimated number of individuals under-saving for retirement depends crucially on the assumption of what parents do with the money that is freed up when their children leave home. The CRR study assumes that households maintain relatively constant consumption over time, which implies that parents increase their consumption when their children become financially independent. In contrast, the optimal savings literature assumes that parents save the additional amount. Parents benefit from this strategy in two ways. First, they are able to quickly build up retirement savings. Second, they keep their per-person consumption low and thus need less money to fund consumption in retirement. The question remains: which assumption matches what parents actually do?

This brief presents the findings of a new study that investigates how, in fact, households behave. It shows that parents maintain household-level and increase per-capita consumption when their children leave home. These findings challenge the idea that parents will automatically save more for retirement when their children are independent, indicating that more households are at risk of an unsatisfactory retirement.

This brief is organized as follows. The first section explains a prominent theoretical model of household savings behavior. The second section describes the data and methodology, while the third section reports the findings. The final section concludes that many households are at risk of falling short of maintaining even the consumption level they had while raising their children, let alone the higher level they have enjoyed since their children flew the coop.

Theoretical Models of Household Savings Behavior

According to the life-cycle model of savings behavior, households should time their savings in order to smooth consumption over their lifetime. Households might aim to enjoy approximately the same level of consumption in all periods, both before and after retirement. This objective would imply that households would save more when income is high and less when income is low.

But households’ needs vary over the life cycle, and may be particularly high when children are at home. Food, clothing, and karate classes all cost money, and so households might optimally plan to spend more during this period. Once the children leave, parents would reduce total household consumption, but maintain the same level of per-capita consumption. This behavior would lead to higher saving, and the total amount of retirement savings needed would be relatively low because the household aims to replace the lower consumption enjoyed after the kids left home, not the higher level enjoyed previously. This pattern is illustrated as Scenario 2, and can be thought of as the per-capita-consumption smoothing assumption.

These two assumptions have very different implications for the optimal timing and amount of retirement savings. A household that plans for a constant level of consumption (Scenario 1) has a high target level of retirement saving, and will not dramatically reduce household spending when the children leave home. However, if the household plans on spending more when the children are home (Scenario 2), it should noticeably decrease consumption and increase retirement savings when the children leave the nest. We test which of these patterns best fits the consumption data.

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CRR: Do Parents Live It Up When Children Fly the Coop?

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