Kevin Milligan looks at how aging people make financial decisions upon their transition from work to retirement - photo by Nic Fensom

UBC Reports | Vol. 52 | No. 10 | Oct. 5, 2006

Retirees Risk Falling into Poverty

By Nick Melling

Economic theories frequently refer to the “rational man,” or homo economicus.

But what happens when this rational man or woman gets old, retires and begins to draw a pension? As his or her income, health and lifestyle change, how will he or she adjust saving and spending habits?

And, for that matter, is this man or woman even so rational to begin with?

These are the questions that Asst. Prof. Kevin Milligan is aiming to answer. Armed with a grant of $58,309 from the Social Sciences and Humanities Research Council of Canada (SSHRC), Milligan looks to find out what factors guide the economic decisions of aging people in Canada and the United States, especially during the transition to retirement from work.

“It’s kind of weird to say I want to spend three years studying ages 62, 63, and 64, but that’s exactly what I want to do,” says Milligan, who has been a member of the Economics Department since 2001.

Milligan says he hopes his research will provide economists and governments valuable information about this pivotal stage of life. The elderly are one of the most economically vulnerable groups in society, he says, largely because most of their economic decisions lie behind them.

Milligan will examine how people prepare -- or don’t prepare -- for retirement, in terms of their income and consumption patterns.

The research will also probe how health-related shocks, such as an immobilizing illness or the death of a spouse, will influence the way people manage their wealth and assets.

The project may help to shed light on two competing theories about how people make economic decisions: the so-called “Lifecycle Model,” which takes the view that people are essentially rational and forward-looking, and the “Behavioural Model,” which argues that people are more heavily influenced by immediate concerns.

Milligan’s data for both projects will be drawn from a Statistics Canada survey and a U.S. Health and Retirement Study from the University of Michigan.

His first task will be to study the link between health and fiscal decision-making. As Milligan notes, this is a topic that has been examined before and his research will be guided by previous observations.

“For example, one of the benchmark findings is that people will very rarely sell their house unless there’s a severe health shock to the family,” he says.

“We’ll look at these different possible hypotheses as to why,” he says. “Is it financial need, is it physical need, is it emotional need?”

A severe shock, according to Milligan, generally means either the death of one spouse or a sudden need for full-time care. But there is also the matter of less pronounced traumas -- injuries and illnesses that may cause discomfort and inconvenience, but are not fatal or seriously debilitating.

The second part of the project will analyze the general patterns of income and consumption among people who are about to retire or have recently done so.

Milligan says, people in this category run the risk of falling into poverty once they stop working. This is particularly true for those who retire before the age of 65 and are not yet eligible to receive their government pensions.

But even establishing the rate of poverty in these circumstances is not a clear-cut process, given that there are at least two ways of measuring it. The usual method for determining poverty is to look at income and to designate a certain revenue threshold as the poverty line.

However, some economists have made the argument that what matters most for assessing quality of life at the end of the day is not income but consumption, since spending will not always be proportional to people’s incomes.

Interestingly, this seems to be exactly what is going on with 60-65 year-olds in Canada, according to Milligan’s previous research.

Though there is a spike in income-based poverty among this demographic group, the consumption-based poverty rate stays largely constant.

Such a trend, suggests Milligan, would on the surface seem to support the forward-thinking “Lifecycle Model” of human economic behaviour: people plan ahead, save money and are thus able to maintain their lifestyles even when their incomes diminish.

However, this is far from definite and Milligan hopes his research will provide some answers.

“If we find out that the initial findings hold up, that income might bounce around a whole lot, but consumption stays really constant over this transition period, that gives us some more evidence in favour of the Lifecycle Model,” he says.

As for the rigorous work of number crunching and analysis, Milligan will have the help of two colleagues, Professors Michael Baker of the University of Toronto and Courtney Coile of Wellesley College, Massachusetts.

He says he’s not undertaking this project solely out of academic interest. At a time when the Baby Boomer generation is nearing retirement, studies of poverty among the elderly may be critical in shaping government actions toward seniors.

“On the public policy side of things, I think it’s pretty obvious that for designing pension policy, whether public or private, having a good idea of the economic risks that are faced by households as they make the transition is pretty important,” he says.

“If everyone is doing okay, then maybe we don’t need to spend the extra billion dollars on seniors, but if there are some real pockets of poverty out there, then maybe we should know that.”

Milligan has been investigating the economic conditions of seniors since the late 1990s, when he researched RRSPs and retirement savings plans for his PhD thesis (University of Toronto, 2001).

He has had at least one opportunity to make practical use of his expertise since then.

“My mother is in her 60s, and it certainly gives her a great advantage to have someone who’s thought a lot about these kinds of things, to give her advice,” he says.

Milligan likes the idea that his work might lead to improved conditions for retirees. But as far as his current research goes, he’s not even sure yet what he could tell them.

“I don’t know where this is going to go,” says Milligan. “What makes me most excited about the project is that I don’t know what we’re going to find, and so I’m intrigued by what it’s going to look like.”

Nick Melling recently received his Bachelor of Arts in History from the University of British Columbia. He plans to begin law school in 2007.