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Retirement Weekly: What happens when the kids leave home?

A key part of your retirement financial plan may be based on a faulty assumption.

I’m referring to whether you’ll save and invest more for your retirement after your children become financially independent. That’s when your earning power is likely to be the highest it will ever be and you have the potential to make major contributions to your 401(k) or IRA. In addition, by earning all you can, you postpone further into the future the time when you have to start withdrawing from your retirement portfolio.

Many financial plans are based on the assumption that you will make those large contributions and postpone retirement withdrawals as long as possible. But researchers have failed to find strong statistical support for this assumption. While the data show that households do in fact decrease their spending after their kids become financially independent, their savings and investments don’t show a corresponding increase. If households are spending less but not saving and investing more, where’s the money going?

A new study from Boston College’s Center for Retirement Research (CRR) set out to tackle this question. Entitled “Do Households Save More When the Kids Leave?,” the study was written by Andrew Biggs, a senior fellow at the American Enterprise Institute; Anqi Chen, a research economist and the assistant director of savings research at CRR; and Alicia Munnell, director of the CRR.

The researchers focused on data from the Health and Retirement Study (HRS) from the University of Michigan. The HRS, which is conducted every two years, is perhaps the most comprehensive examination available of attitudes toward retirement; it is based on a survey of around 20,000 Americans over the age of 50. After considering—and ultimately rejecting—several other possible answers to the question “where’s the money going?,” the researchers arrived at a tentative answer: Parents are choosing to work less after their children become financially independent. That explains how it can be true that both household consumption and savings/investing decline.

How much less are parents choosing to work? The accompanying chart provides an answer. On average, according to the researchers, the hours worked per week stand at 53 or higher in the years immediately prior to their children becoming financially independent. This steadily drops in the subsequent years, and by the sixth post-independence year the average stands at around 37. (These numbers not only reflect averages across many different households, but across different definitions of when children achieve financial independence.)

Not necessarily irrational

I hasten to add that it isn’t necessarily irrational for parents to work less after their kids leave home. It doesn’t automatically make sense for them to continue knocking themselves out working in order to save and invest for a retirement that is uncertain. As economists teach us, when uncertainty is higher we need to discount the future at a greater rate when calculating its present value. A near-retiree who views the future as particularly uncertain may be entirely rational in not saving and investing as much as financial planners traditionally recommend.

There’s another reason why it’s not necessarily irrational for parents to work less after their kids leave home: Leisure time when you’re younger can be more valuable than the equivalent amount of leisure time when you’re much older. A retiree in her late 60s might very well enjoy travel a lot more than when she’s in her 80s, for example.

These all are highly personal considerations, of course. But what would be irrational is for you to base your retirement financial security on the assumption that your savings rate and investments will rise significantly after your children become financially independent—and then not to follow through. In that event you’re setting yourself up for a rude awakening once you do retire.

The key, in other words, is to be realistic. If you want to work, save and invest less after your kids become financially independent, then make sure that is accurately reflected in your retirement financial plan.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

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