The Age-Saving Profile and the Life-Cycle Hypothesis

Abstract

The Life-Cycle Hypothesis posits that saving should be positive for households in their working span and negative for the retired ones, and wealth therefore should be humpshaped.Yet, if one looks at the microeconomic evidence on saving by age, dissaving by the elderly is limited or absent.The measures of saving generally used in previous tests are based on a concept of income that does not properly take into account the role of mandated public pension arrangements, to wit, disposable income.This measure treats pension contributions as taxes, and pension benefits as transfers.In reality, contributions represent an accumulation, or saving, designed to provide for post-retirement income in the form of a pension.That contribution should therefore be recognized as (mandatory) allocation of income to life cycle saving.Accordingly, pension contributions should be added back to disposable income and to discretionary life cycle saving.Similarly, pension benefits accruing to the retired do not represent income produced, but a drawing from the pension wealth accumulated up to retirement.We use Italian repeated cross-sectional data from 1989 to 2000 to show that when this adjustment is performed, saving and wealth over the life cycle exhibit the characteristic hump shape implied by LCH, and that the adjustment also contributes to an understanding of the saving behavior of the elderly.

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