Understanding What Happens to Inherited Wealth Jay

Do People Save or Spend Their Inheritances? Understanding What Happens to Inherited Wealth Jay L. Zagorsky

Journal of Family and Economic Issues ISSN 1058-0476 Volume 34 Number 1 J Fam Econ Iss (2013) 34:64-76 DOI 10.1007/s10834-012-9299-y

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Author's personal copy J Fam Econ Iss (2013) 34:64–76 DOI 10.1007/s10834-012-9299-y

ORIGINAL PAPER

Do People Save or Spend Their Inheritances? Understanding What Happens to Inherited Wealth Jay L. Zagorsky

Published online: 13 March 2012 Ó Springer Science+Business Media, LLC 2012

Abstract Almost $4 trillion dollars of wealth is currently held by families with a life expectancy of less than 10 years. When that wealth is inherited, will it be retained or spent quickly? Results from the NLSY79, a longitudinal survey covering people in their 20s, 30s, and 40s suggest roughly half of all money inherited is saved and the other half spent or lost investing. These spending and saving decisions are made by a concentrated group with about one-fifth of all families getting an inheritance and about one-seventh expecting to receive an inheritance. Suggestions to increase savings from inheritances are discussed. Keywords

Bequest Inheritance Saving Wealth

Introduction Is wealth that is passed down from one generation to the next retained or is it spent quickly? In 2007 people 65 years old and over held almost one-third ($20 trillion) of the $64 trillion of U.S. wealth. What will happen when these people die and pass on their wealth in the biggest wealth transfer in history (Kotlikoff and Summers 1981)? This research suggests about half of that wealth will be spent, given away or lost quickly. Researchers and policy makers actually know relatively little about people’s actions when they receive an inheritance. Bequests and inheritances are often windfalls. An individual has primarily two choices with a windfall: the

J. L. Zagorsky (&) Center for Human Resource Research, The Ohio State University, 921 Chatham Lane, Suite 100, Columbus, OH 43221, USA e-mail: [email protected]

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money can be saved or spent. How much is saved? How much is spent? How many people get an inheritance and how much do they get? What happens to inheritances is important information for families, financial markets, and for the country. If families primarily save inheritances, then households will have larger financial cushions, reducing the possibility of future foreclosures (Collins 2007), credit card defaults and bankruptcy filings (Moorman and Garasky 2008). Also many families have not saved enough for retirement or for their children’s college education (Yilmazer 2008). Inheritances can help make up these shortfalls. Families that primarily spend the money will boost their current enjoyment and consumption but will not improve their financial situations. Financial markets are affected if recipients spend most of the financial wealth they inherit. Liquidating inherited stocks and bonds causes prices to fall in financial markets. Moreover, while financial liquidation boosts consumption it also reduces the funds available for investment. This means any large liquidation of transferred financial wealth will reduce already low domestic savings and require more imported capital for future investments. The U.S. federal government and many states have estate taxes which take a portion of a deceased person’s wealth. Even though federal inheritance taxes affect relatively few families and raise relatively little revenue (Jacobson et al. 2007) these taxes generate a huge amount of political attention.1 Congress changed key parts of U.S. inheritance tax law in 2001 with Title V of the ‘‘Economic Growth and Tax 1

In 2007 the estate tax was paid by the estates of 17,416 deceased individuals and raised $26 billion out of the $2.6 trillion of federal revenue, which is about 1% of federal income.

Author's personal copy J Fam Econ Iss (2013) 34:64–76

Relief Reconciliation Act’’ (U.S. Congress 2001) and then changed the rules again in 2010 with Title III of the ‘‘Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act’’ (U.S. Congress 2010). The two acts lowered the maximum tax rates slowly over time and also raised the minimum estate size exempted from taxation.2 The issue will become politically important again when the estate tax rules expire in 2012. Battles over whether inheritances should or should not be taxed are not new. For example, John Stuart Mill (1848, Book V, Chapter III), one of the early classical economists, suggested over one-hundred and fifty years ago inheritance taxes were better than income taxes. The arguments for and against inheritance taxes have continued ever since Mill made his argument (Kotlikoff et al. 2003; Kotlikoff and Summers 1981; Laitner 2002; Modigliani 1986). Opponents of inheritance taxes often state that this tax discourages savings.3 Proponents often focus on the ability of inheritance taxes to reduce a country’s wealth inequality and reduce the ability for dynastic families to maintain control of resources for multiple generations (Wall Street Journal 2010). The questions asked above are answered using data from two large random samples of the U.S. population. Answers about the number of people receiving an inheritance and the amount they inherit come from the Survey of Consumer Finances (SCF) funded by the Federal Reserve. Answers on spending and savings are based on National Longitudinal Survey of Youth 1979 cohort (NLSY79) funded by the Bureau of Labor Statistics, which tracks changes in the same group of people over time. This research does not examine inheriting items of sentimental value such as family photographs, clothes, jewelry, and treasured objects. Stum (2000) points out that these items are sometimes even more important to heirs after the death of a loved one than money.

Literature Review Why do people save? Browning and Lusardi (1996), who built on the work of Keynes (1936), covered nine primary reasons why people save. One of the nine reasons is that 2

In 2001 the maximum tax rate was 50%. This rate was steadily lowered over time with a rate of 46% in 2006 and then 45% in 2007, 2008 and 2009. For 2010 to 2012 the rate is 35%. In 2006, 2007 and 2008 the exemption amount was $2 million. In 2009 the exemption was $3 million. For 2010 to 2012 the amount is $5 million. 3 For example, assume two people each earned $10 million during their lifetime. If the first person consumed all of his earnings, there would be no inheritance taxes since there is no estate. If the second person saved half his earnings then his heirs are taxed on $5 million. By taxing the second person, who consumed less, the government penalizes savings.

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people want to leave a bequest so that their beneficiaries can enjoy higher spending after their death. Relatively little empirical research has tracked how much people save of their inheritance. Joulfaian (2006, p. 4), used U.S. tax records to track the savings of wealthy American heirs. Matching estate tax returns from 1989 with the inheritors’ income tax returns from before and after 1989 showed ‘‘that wealth increases by only a fraction of the inheritances received.’’ His regressions showed that for every dollar inherited wealth increased between 59 and 79 cents. Unfortunately, these results applied only to the heirs of the wealthy since only estates worth more than $600,000 in 1989, which is about $1.1 million today, had to file estate tax returns in 1989. Moreover, his savings estimates are not based on actual wealth but instead on an estimate of wealth based solely on interest and dividends reported on income tax returns, which produced biased figures (Johnson et al. 2005). Inheritances have similar characteristics to lottery prizes (Clotfelter and Cook 1990) since both give unearned windfalls to recipients. Research shows lottery winners saved just 16 cents of every dollar won (Imbens et al. 2001),4 bankruptcy rates soared for lottery winners 3–5 years after winning (Hankins et al. 2009) and college gamblers had more problematic financial behaviors than non-gamblers (Worthy et al. 2010). These facts suggest many people quickly spent windfalls. However, lottery winners likely have lower savings rates than inheritors because some inheritors expect to receive money, even if the exact timing, amount, and conditions are unknown or are surrounded by uncertainty. Other research has examined where individuals got their wealth. Wolff (1999) used a simulation model based on the SCF and the Consumer Expenditure Survey. He estimated that for the average head of a household born during World War II, about one-third of their wealth was inherited, onethird was gifts, and one-third was saved. Among the 400 richest Americans Canterbery and Nosari (1985) found inheritors had about $100 million more wealth even after adjusting for age, gender, industry, and if the person was actively employed. Unfortunately, neither of these papers directly answered how much of the inheritance was actually saved. Research has also investigated the impact of inheritances on people’s lives. Joulfaian and Wilhelm (1994) found, using the Panel Study of Income Dynamics and the U.S. Treasury’s Estate-Income Tax Match sample, that inheritances caused only a small negative impact on hours worked and a small positive impact on consumption. However, Holtz-Eakin et al. (1993) found that a small but 4

While winners might not save their prizes, they were happier 2 years after winning than non-winners (Gardner and Oswald 2007).

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significant share of people completely dropped out of the labor force after receiving a large inheritance. Families transmit their lifestyle (Ponthiere 2011), preferences (Gouskova et al. 2010) and left over wealth (Hurd 1989; Hurd and Smith 2002). Sometimes extra wealth passed down as a bequest is accidental. The extra wealth can be due to unexpectedly high investment returns, lower consumption caused by sickness, early death, or other factors. Alessie and Kapteyn (2001) found using Dutch data that 60% of people were not actively trying to leave a bequest. Not all left over wealth is transmitted to family members. Sometimes money is donated to charities (Chan 2010). Some people actively try to leave a bequest. Jianakoplos et al. (1996) found that respondents wanting to leave a bequest saved 7% more. Research has investigated why some people are actively trying to leave bequests to children, grandchildren, and others (Behrman and Rosenzweig 2004; Kotlikoff and Summers 1981).5 One reason people try to leave a bequest is an exchange motive. Children who help out their parents in old age are compensated for this help after death by a bequest; help is exchanged for money. Caputo (2002), however, found expecting or not expecting an inheritance did not impact the amount of care daughters provided elderly parents. Another reason for leaving an inheritance is an altruistic motive. Some parents try to equal out their children’s financial resources by giving larger inheritances to poorer children and smaller inheritances to richer children. Arrondel and Masson (2001) showed using French data that children were more likely to get a bequest if their parent had received a bequest. This suggests not only a learning effect but parents might believe multi-generational wealth transmission was important in France. Dunn and Phillips (1997), using the AHEAD survey and MacDonald and Koh using Wisconsin data (2003), found that at death most families in the U.S. treat all children equally regardless of financial circumstances.

Theoretical Framework How do people increase their wealth? There are four methods. First, people can save their money by spending less than they earn. Second, they can grow their wealth by investing in items that increase in value. The most common method of growing wealth is by purchasing assets which are expected to have positive capital gains such as stocks or 5 Goetting and Martin (2001) found the presence of a written will was strongly influenced by an older adult’s belief that he/she will make a bequest. Davies (2011) examined reasons why people gave gifts while alive.

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real estate. Another alternative is to invest the money in an asset that pays a positive interest rate such as bonds, CDs, or savings accounts. The third method is to steal or confiscate assets from others. The fourth way to increase wealth is simply to be given it. This research looks at how much wealth increases from this last method. When people are given large inheritances or large gifts they have just five realistic choices. First, they can spend it.6 Second, they can use it to pay off their debts. Third, they can save or invest the money. Fourth, they can donate it. Finally, they can refuse the gift or inheritance (Hube 2006, p. R7). Wealth does not change if a person spends, donates, or refuses an inheritance. Wealth typically increases if the money is invested or if it is used to pay down previous debt, because wealth is calculated by subtracting liabilities from assets. Savings encompasses a number of ideas (Tachibanaki 1994; Warneryd 1999). One idea is that savings occurs when a person spends less than his/her income and puts the rest away for future consumption. A different more expansive idea of savings is the change in wealth from 1 year to the next. The more expansive concept classifies savers as individuals whose wealth increased over time. Due to data limitations this research cannot look at the first saving concept, but adopts the second as its definition. Unfortunately, this second concept has one major problem. When individuals experience a capital loss, for example when home values fall, they are classified as having negative savings, even if they spent less than their income during the entire year. Below is a simple framework that takes these concepts and codifies how savings is derived in general from each person’s income and wealth. Income, I, is the amount of money earned by a person in each time period, t, such as a weekly or monthly paycheck. Net worth, NW, also called wealth in this research, calculates the total resources available at a single point in time by subtracting the current value of all debts from all assets. Most people derive their income from three sources; earnings, transfers, and investments. Earnings, E, are the amount of money received in wages, salaries, bonuses, tips, commissions, and self-employment income in exchange for work. Transfers, T, are funds usually provided by the government that are given to people based on their meeting certain criteria. Examples of transfer payments are welfare payments given to the poor, worker’s compensation given to the injured, and Social Security given to retirees. Investment income consists of items like interest and dividends and is a function of net worth: 6

Research by Waldkirch et al. (2004) suggested many individuals follow the spending and saving habits of their parents, even after adjusting for income differences.


It ¼ Et þ Tt þ f ðNWt Þ

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ð1Þ

24%

Wealth is changed via three different channels: spending less or more than is earned; having capital gains or losses; and giving or receiving inheritances and gifts. These methods are summarized in Eq. 2 which states net worth is changed first by the difference between income and consumption, C, over the time period. Second, by capital appreciation or depreciation, formally written as one plus the return, r, on last period’s wealth. Finally, net worth is changed by the net amount of gifts, G, or inheritances received during the time period:7

22%

Inherited

NWt ¼ ðIt Ct Þ þ ð1 þ rÞNWt1 þ Gt :

ð2Þ

Expect Inheritance

20% 18% 16% 14% 12% 10% 1989

1992

1995

1998

2001

2004

2007

Savings, S is tracked by taking the first difference of Eq. 2. Equation 3 shows savings can be either positive or negative depending on the current and past levels of wealth.

Fig. 1 Percentage of all U.S. families who inherited money and expect to inherit

St ¼ NWt NWt1

The SCF has complex procedures to impute missing values since many individuals do not know or do not completely reveal financial information. Additionally, to protect respondents’ identities the SCF releases five slightly different sets of data for each family. The average of all five sets was used to obtain results in this research. SCF details are found in Bucks et al. (2006) and are available at www.federalreserve.gov/boarddocs/surveys. Figure 1 used SCF data to track the percentage that have already inherited (solid grey on left) and expect to inherit (cross-hatched on right). Data on inheritance come from questions like X5801 in the 2007 survey which asked, ‘‘have you (or your [husband/wife/partner]) ever received an inheritance, or been given substantial assets in a trust or in some other form? If yes: please do not include inheritances from a deceased spouse.’’ The solid bars in the figure show a ‘‘U’’ shaped pattern among those who already received an inheritance. In 1989 almost one-quarter (23.5%) of families had received an inheritance. The percentage getting an inheritance fell below 18% by 2001 and then rose to over one-fifth (21%) by 2007. The shorter right side cross-hatch bars track expectations of inheriting. Data on expectations came from questions like X5819 in the 2007 survey which asked, ‘‘Do you or your (husband/wife/partner) expect to receive a substantial inheritance or transfer of assets in the future?’’ Kao et al. (1997) investigated the 1989 SCF data and found being more educated, married, white, and having fewer siblings increased the anticipation of receiving an inheritance. Overall the data show expectations were drifting down over time. Over 18% (18.3%) in 1989 believed they would inherit compared to just 13% in 2007. Table 1 shows the average amount inherited. Since the SCF provides the years and the amounts inherited, values were adjusted using the consumer price index (CPI-W into

ð3Þ

Equations 1 and 2 show circularity because income and spending help determine wealth and savings while at the same time some income is derived from wealth holdings. Analysis using the same NLSY79 data as this research (Zagorsky 2007) shows the feedback effects are not important. Feedback is unimportant because the data are based on individuals who have relatively little wealth and derive little or no income from interest and dividends. NLSY79 cohort members, who were all born between 1957 and 1964, derive about 87% of their income from wages and almost all the rest from government transfers. Because there is no feedback between Eqs. 1 and 2 more sophisticated statistical techniques are not needed in the analysis of NLSY79 cohort members’ inheritances.

Background Information How much money was inherited and how much more do U.S. families expect to inherit? The Federal Reserve Board of Governors’ Survey of Consumer Finances (SCF) answers these questions. The SCF is a cross-sectional faceto-face interview which collects detailed information on wealth and inheritances from about 4,000 U.S. families every 3 years.8

7

Contributions made by someone else, such as company matches to a defined contribution plan, are not included in the model since the NLSY79 data set does not track this information. 8 The SCF is comprised of two samples; a random cross-section and an over-sample with very high income. Using the survey weights ensures the over-sample’s responses do not bias the results and enables this research’s tables and graphs to be interpreted as national figures.

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Table 1 Average amount received among U.S. families who inherited money Year

Median $ Inherited

Mean $ Inherited

1989

$40,834

$208,211

1992

$30,348

$134,004

1995

$39,208

$179,770

1998

$42,236

$158,252

2001

$53,188

$174,946

2004

$54,609

$246,533

2007

$58,467

$238,672

All figures adjusted for inflation using CPI-W and are in 2009 dollars 36% 34% 32% 30% 28% 26% 24% 22% 20% 18%

1989

1992

1995

1998

Expects To leave Sizable Estate

2001

2004

2007

Very Important to Leave Estate

Fig. 2 Percentage of all U.S. families who want or expect to leave estate

2009 dollars) to eliminate inflation distortion.9 The key point of Table 1 is found in the middle column labeled ‘‘median $ inherited’’ which ranges from over $30,000 to over $58,000. These figures show many people did not inherit a large windfall. For example, the median amount inherited in 1989 ($40,834 in 2009 $) was just two-thirds of a year’s income. The right column, which tracks the mean amount, ranges from over $134,000 to over $246,000. These figures suggest relatively few families inherited substantial amounts. Figure 2 shows expectations about leaving a sizable estate. In 1989 over one-quarter (28.4%) of all families expected to leave money but by 2007 the ratio had risen to one-third (33.5%). Not only are more people expecting to leave money to heirs but as the graph’s cross-hatched bars show it is increasingly viewed as very important. Coleman and Ganong’s (1998) research, backed up by Hayhoe and Stevenson (2007), show people expect bequests to be made based on genetics and family ties, not lifetime actions such as maintaining relationships.

9

The SCF tracks up to four inheritances. Most U.S. families (75.8% in 2007) report just one inheritance.

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How much money will be transferred via inheritances? Table 2 combines life expectancy data based on the youngest or only adult in the family with SCF net worth figures for 2007. The table shows 800,000 U.S. families in 2007 were expected to live less than 5 years. These families hold less than 1% of all wealth, with a median net worth of $226,500. The total wealth column shows this group will transfer about $328 billion to heirs, charities or the government for taxes.10 Extending life expectancy from 5 to 10 years adds an additional 6.4 million households who can transfer over three and a half trillion dollars. While $3.5 trillion is large, this represents just 5% of total U.S. wealth. Most U.S. wealth (54%) was held by families with a life expectancy of more than 25 years. This suggests most U.S. household wealth will not change hands because of death for more than a quarter of a century. How much wealth came from inheritances? Unfortunately, SCF data cannot address this question since the survey does not record wealth prior to receiving an inheritance. Inherited money can grow or shrink because of capital gains and losses. Inheritances can also be spent and then replaced. Nevertheless, the ratio of inheritances to net worth provides a rough indication. Table 3’s top line shows the median family that inherited money received a gift worth about one-fifth their current net worth. The second and third lines show some inheritors did not save the bequest. Two and a half percent of those who received an inheritance presently had a negative net worth. This indicates that at least this percentage either spent the entire inheritance or had a capital loss that wiped out the inheritance’s value. Over 15% (15.1%) of families had a current net worth value smaller than the amount they inherited, indicating some of the inheritance was spent or lost via capital losses. These results are similar to Joulfaian’s (2006) wealth mobility table, which shows between 8 and 29% of people had less wealth after inheriting. The bottom part of Table 3 shows the inheritance’s source. Because some families received multiple inheritances (24.2% of inheritors in 2007) the total from these six lines is more than 100%. The most important source of inheritances was from a respondent’s parents or in-laws (67.5% overall average). The second largest source was from grandparents (19.1%), while the third was from aunts or uncles (15%). About ten percent of families received inheritances from other sources like siblings, friends, children, and other family members.

10 Havens and Schervish (2003) estimated that 60% of transferred wealth goes to heirs and 40% to charity, taxes, and estate settlement expenses.


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Table 2 Amount of wealth available for transfer in 2007 (in 2009 $) Family life expectancy

Number of households (Millions)

\5 years

0.8

Median wealth

Total wealth (Billion $)

Percent of wealth (%)

$226,506

$328

\1

5 to \10 years

6.4

$210,379

$3,545

5

10 to \15 years

6.8

$237,155

$4,995

7

15 to \20 years

8.3

$229,711

$8,108

12

20 to \25 years

12.3

$300,869

$13,717

21

81.4

$78,558

$35,986

54

$66,679

100

C25 years Total

116.1

Family life expectancy is calculated as the life expectancy figure found in Arias (2007, Table 1, p. 8) minus age of the respondent for a family with a single adult. In two-adult families the life expectancy of the younger adult is used Table 3 Ratios of inheritance to net worth and source of inheritances 1989 (%)

1992 (%)

1995 (%)

1998 (%)

2001 (%)

2004 (%)

2007 (%)

Average

25.6

17.1

20.4

22.0

20.0

21.2

21.7

21.2

1.5

1.4

3.5

3.0

1.5

3.7

3.2

2.5

20.0

12.5

15.7

15.7

12.4

14.9

14.9

15.1

Parent

61.7

61.1

69.3

71.6

70.2

66.3

72.7

67.5

Grandparent

20.5

21.5

16.7

17.3

19.0

19.4

19.5

19.1

Aunt or uncle

16.0

17.6

17.4

13.2

12.2

16.2

12.3

15.0

Sibling

5.1

5.2

4.8

4.0

3.2

3.8

3.9

4.3

Friend

4.5

4.3

3.9

4.0

3.5

3.2

2.5

3.7

Family/child

0.0

0.0

2.4

3.1

2.1

4.1

1.8

1.9

Median ratio of inherit $ to net worth Spent all $ inherited Spent some $ inherited Gift from

Totaling the gifts from all sources sums to more than 100% since some respondents received multiple inheritances. Transfers from a deceased to a living spouse are not classified as an inheritance

Methodology Since the SCF cannot answer how much of an inheritance was saved versus spent information from another source, the National Longitudinal Survey of Youth 1979 cohort (NLSY79), was used. The NLSY79 data can answer the question since it contains both inheritance and savings data. The NLSY79 is a large randomly selected nationally representative ongoing U.S. panel survey of over 9,000 respondents. The survey’s primary funding is from the Bureau of Labor Statistics. General survey details and the data used in this research are available online at www.bls.gov/nls. The survey has questioned the same group of young baby boomers 23 times; annually from 1979 to 1994 and every other year since 1994. These boomers are individuals born between 1957 and 1964, at the tail end of the birth spike that began after World War II. While NLSY79 data start in 1979, this research focuses on data starting in the mid 1980s, when wealth and inheritance questions were first introduced. Readers are cautioned that results from the NLSY79 are applicable only for young baby boomers and that the survey does not over-

sample the rich, who are more likely to get inheritances. The next subsections discuss the measures used in this research: inheritance information, wealth, savings, and income. Inheritances Inheritance questions were first included in the 1988 survey. Other research that has used NLS surveys to investigate inheritances include Light and McGarry (2004), Mulligan (1999), and Pabilonia (2001). Respondents are asked two questions. The first asks if during the past calendar year ‘‘you [or your (husband/wife)] received any property or money, valued at over $100, from any estates, trusts, inheritances, or gifts from relatives or friends?’’ If the answer is yes, the respondent is then asked for the total market value or amount received.11 In 1988 respondents 11

Respondents who are confused by the term total market value are told the following definition. ‘‘Market value is defined as how much the respondent would reasonably expect someone else to pay if the item(s) were sold today in its/their present condition: not the original price paid for the item(s).’’

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were asked both the standard question about the amounts received in the past year (1987) and asked to report all inheritances received prior to 1987 and the year in which they were received. Since inheritance questions are included in every survey since 1988 it is possible to create almost a complete picture of inheritances. A complete picture is missed because a small number of inheritances were overlooked in the 1988–1998 questionnaires. These surveys asked respondents to report inheritances received in just the past calendar year. Because of the question’s wording there are potentially gaps if a respondent missed a survey or received an inheritance in the late 1990s when the survey was fielded biennially.12 The wording problem was rectified with the 2000 survey in which respondents are asked to report all inheritances since the last interview date. Relatively few inheritances are overlooked because of missed surveys since most eligible respondents completed all nine surveys from 1988 to 1998 (median 9; mean 8.03). The data show that from age 21 to their mid 30s NLSY79 respondents received relatively small amounts (*$3,500). As respondents aged the value of inheritances began to rise, with a median amount of slightly less than $12,000 when they were in their 40s.

Wealth and Savings Wealth and savings data were calculated from the NLSY79 wealth modules, which were fielded 13 times from 1985 to 2004. Each module asked respondents to report details about their assets and liabilities such as the current market value of their home, mortgage, savings, possessions, stocks, and bond holdings. The earliest modules asked a small number of broad questions such as ‘‘what is the value of any vehicles you own?’’ Later modules broke these broad questions into more detailed components. For example, the 2004 module asks respondents to separately state the market value of up to 15 different vehicles. Equation (4) was used to calculate total net worth. After creating the total, all figures were adjusted for inflation to ensure all money figures are directly comparable. More details on response rates, handling of missing values, and accuracy of the NLSY79 wealth data are found in Zagorsky (1999).

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Net Worth ¼ Home Value Mortgage Property Debt þ Cash Saving þ Stock=Bond=Mutual Funds þ Trusts þ Business=Farm=RE Value Business=Farm=RE Debt þ Car Value Car Debt þ Possessions Other Debt þ IRA þ 401K þ CD

ð4Þ

The amount of savings was calculated by subtracting adjacent inflation-adjusted net worth values. For example, if a respondent reported a value of $20,000 of net worth in 1998 and $30,000 in 2000, then they had saved $10,000 over the time period. Respondents who missed a survey had savings calculated over a wider time span, but the survey’s high response rate means most respondents have savings calculated over just 1–2 year intervals. Income Data on income and the change in income were calculated in a similar manner to wealth and savings. Responses were first taken from the NLSY79 income modules which asked respondents four sets of questions. The first set asked respondents questions that determine income from wages, salaries, tips, and self-employment. The second set asked for details about government transfers and welfare payments. The third set asked about private transfers such as child support, alimony, and gifts. Finally, respondents listed income from other sources such as scholarships, interest, dividends, and rent. For the most important items, such as wages, the questions are asked once about the respondent’s income and then repeated a second time to capture income for a spouse or partner. For less important items, such as interest or dividends, a single question asks how much money both the respondent and spouse, if one exists, received. Using Eq. 5, family income was created by summing the various components from each survey’s income module. As with wealth, all values were adjusted for inflation. Family Income ¼ Military Pay þ Wages þ Net Business Profits þ Alimony þ Child Support þ Education Grants þ Other Income þ Gifts þ Welfare þ Food Stamps þ Unemployment Insurance þ Worker Compensation:

ð5Þ

Results 12

In the 1996 and 1998 surveys the questions asked if the respondent received money in 1995 and 1997. Because the surveys were biennial in 1996 and 1998, respondents were not directly asked about inheritances in 1994 and 1996.

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Results are shown in four sections: graphical analysis, descriptive statistics, savings details, and financial regressions. Results were computed using the SAS statistical


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$4,000,000

Table 4 Demographics of NLSY79 respondents by inheritance status in 2008

$3,000,000

Characteristic

All people

People who did not get an inheritance

People who received inheritance

White*

78.2%

75.8%

91.1%

% Female

51.2%

50.8%

53.9%

Avg. age in years*

46.6

46.6

46.9

-$2,000,000

% married*

62.4%

60.7%

72.3%

-$3,000,000

Family size*

2.9

2.8

3.0

Number of children*

1.9

1.9

1.8

$2,000,000

Saved

$1,000,000

$0

-$1,000,000

-$4,000,000 $10

$100

$1,000

$10,000

$100,000

$1,000,000

$10,000,000

Inherited

Fig. 3 Amount inherited and amount saved U.S. young baby boomers (2009 dollars)

package. Since the NLSY79 is a multi-stage survey that over-sampled blacks and Hispanics the data were adjusted following the recommendations in chapter 3.3 of the NLSY79 User Guide13 to ensure results represented the experiences of all young baby boomers. Graphical Analysis Figure 3 compares how much young baby boomers inherited versus how much their wealth changed. The graph has inheritances on the x-axis in a logarithmic scale. The y-axis tracks savings but because it is impossible to take the logarithm of a negative number this axis is in absolute dollars. Visually the figure shows a huge clustering around the horizontal axis. In simple terms, no matter what the inheritance most of the saving was close to zero. Moreover, the figure shows that over one-third (36%) of the time when someone received an inheritance (8,180 observations) they had zero or negative savings (2,944 observations). Descriptive Statistics Do people who receive inheritances have a different background than those who do not? This section shows that young baby boomers who received inheritances were more likely to be white, female, educated, married, and from a smaller family than people not receiving. Table 4 shows the demographic makeup of NLSY79 respondents who participated in the 2008 survey. Creating the tables (not shown) for other survey years resulted in similar numbers. In Table 4 three columns track the entire sample: all people (7,514 people), respondents who did not get inheritance (6,646), and people who received 13

Found online at http://www.nlsinfo.org/nlsy79/docs/79html/ 79text/tocusing/weights3_3.html.

Number of siblings*

3.3

3.4

2.8

Years school completed*

13.8

13.6

14.9

Number of jobs ever held

11.8

11.8

12.1

% working full time

73.1%

73.2%

72.9%

Spouse work full time*

47.9%

47.0%

52.7%

Any self employment*

15.3%

14.7%

18.7%

New job since last int.*

24.2%

24.8%

20.2%

Married since last int.* Divorced since last int.

0.3% 0.3%

0.4% 0.3%

0.01% 0.2%

Had child since last int.

1.4%

1.4%

1.5%

Number observations

7,514

6,646

868

The * after the characteristic shows lines where the values for people getting and not getting an inheritance are statistically different at the 1% level. The results are weighted to represent all U.S. young baby boomers. Asians and Native Americans are grouped in the white category

inheritance (868). The time frame used for tracking who got an inheritance was 2004–2008, the dates of the most recent NLSY79 wealth surveys. The table shows people who received inheritances were disproportionately white (91.1%) compared to non-inheritors (75.8%). Inheritors (53.9%) were more likely to be female than non-inheritors (50.8%). Inheritors were more likely to be married (72.3%) than those not getting an inheritance (60.7%). Inheritors had fewer siblings (2.8 versus 3.4) and 1.3 more years of schooling than those not inheriting. Finally, people who received an inheritance were more likely to report being self-employed (18.7%) than those not getting an inheritance (14.7%) and were less likely to have gotten a new job. While the above demographic factors point out some clear differences, the two groups were quite similar along many other dimensions. Respondents in both groups had a similar age (*47 years), number of people in their families (*3), roughly the same number of children (*2). In addition, the percentages were similar and cannot be statistically differentiated between the groups for the number of jobs held over their lifetime (*12), percentage working full-time (*73%) and major life change factors like being divorced or having a child since the last interview.

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Table 5 Financial indicators for NLYS79 respondents by inheritance status (in 2009 $) Characteristic

All people

People who did not get an inheritance

People who received inheritance

$52,474

2008 survey Amount inherited mean*

$8,001

$0

Amount inherited median*

$0

$0

$11,340

Saving mean*

$66,801

$54,883

$132,965

Saving median*

$12,130

$8,356

$56,331

Saving time span

4.4

4.4

4.3

Net worth mean*

$345,665

$305,792

$567,294

Net worth median*

$141,051

$123,171

$286,870

Income mean*

$52,285

$50,785

$60,452

Income median* Number observations

$40,265 7,514

$39,235 6,646

$46,519 868

All observations Amount inherited mean*

$2,546

$0

$27,679

Amount inherited median*

$0

$0

$4,832

Saving mean*

$24,318

$20,052

$65,335

Saving median*

$2,550

$2,124

$13,103

Saving time span mean years*

1.7

1.6

2.0

Net worth mean*

$122,255

$106,046

$282,239

Net worth median*

$24,753

$21,662

$82,332

Income mean*

$39,241

$38,134

$50,001

Income median* Number observations

$31,036 126,096

$30,447 117,332

$38,004 8,764

The * after the characteristic shows lines where the values for people getting and not getting an inheritance are statistically different at the 1% level. Results are weighted to represent all U.S. young baby boomers

Table 5 shows key financial indicators for NLSY79 respondents. The table’s top part tracks responses from the 2008 survey while the bottom part tracks all observations since 1985. Summarizing the table is simple: respondents who received an inheritance were financially better off along all dimensions than those who did not inherit money. How much money did inheritors receive? In the 2008 survey, which for most respondents covers inheritances over the past 4 years, young baby boomers received a mean of fifty-two thousand ($52,474) and a median of eleven thousand ($11,340). In the All Observations section, which covers NLSY79 respondents’ entire lives, the amount inherited was roughly fifty percent smaller with a mean value of $27,679 and a median of $4,832. Lines labeled savings show the change in net worth over time. Savings among inheritors was more than twice the amount they inherited. For example in 2008, the mean inheritor increased their net worth by $132,965 while the mean inheritance was only $52,474. The savings time span

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shows over how many years savings was calculated. The overall figure at the bottom of the table was 1.7 years, which means the savings calculation usually spans slightly more than a year and a half. Since no wealth survey was done in 2006, savings data from the 2008 survey were calculated over slightly more than a 4 year (4.4) time span. Lines labeled net worth show the value of all assets minus all liabilities. In 2008 overall mean net worth was over a third-of-a-million dollars ($345,665). However, individuals who received an inheritance had almost twice the wealth ($567,294 mean; $286,870 median) of noninheritors ($305,792 mean; $123,171 median). In the All Observations part of the table inheritors ($282,239 mean; $82,332 median) had almost triple the wealth of noninheritors ($106,046 mean; $21,662 median). Lines labeled income show the amount of money received annually. While the net worth lines show inheritors had double or triple the wealth of non-inheritors, the income gap was much smaller. For example, in 2008 the mean income of inheritors ($60,452) was only ten thousand dollars or roughly one-fifth more than non-inheritors ($50,785). Savings Details Table 5 shows that the median inheritor’s savings were roughly six times more than non-inheritor’s. For example the median savings for an inheritor in the All Observations section was thirteen thousand ($13,103) while non-inheritors saved just two thousand ($2,124). However, these overall averages mask a tremendous variety in the saving experiences. Table 6 shows many people who received an inheritance did not have positive savings even with the gift. Overall, more than one-third (34.9%) of all inheritors saw a decline or no change in their wealth after getting an inheritance. The top two lines of Table 6 are very important because people who had zero or negative saving after receiving an inheritance spent or lost it all and saved nothing. Breaking the savings figures down by the amount inherited shows the percentage spending their entire gift declined as the inheritance amount rose. Among boomers who inherited less than one-thousand dollars, over 40% (41.6%) spent their gifts. This percentage declines to a low of 18.7% for people who received $100,000 or more. Nevertheless, even this 18.7% figure means that almost one-in-five young baby boomers who inherited a significant amount spent or lost all of it. Regressions How much did people save and spend out of their inheritances? Table 7 shows the key regression results quantifying the relationship between money inherited and


73

Table 6 Percent of inheritors who saved by inheritance amount (in 2009 $) Amount inherited

Overall among inheritors

$1 to $999

$1,000 to $4,999

$5,000 to $9,999

$10,000 to $49,999

$50,000 to $99,999

$100,000 and above

No inheritance

Negative savings

33.9%

39.8%

36.8%

34.2%

29.5%

29.5%

18.2%

39.1%

Zero savings

1.0%

1.8%

0.8%

1.3%

0.5%

0.6%

0.5%

4.0%

Positive savings Number observations

65.1% 8,180

58.5% 2,174

62.5% 2,272

64.5% 1,043

69.9% 1,932

69.9% 352

81.3% 407

56.9% 106,608

Results are weighted to represent all U.S. young baby boomers

Table 7 Regressions explaining the amount saved from an inheritance

$ Inherit

Amount saved (1)

Amount saved (2)

Amount saved (3)

$0.64 (14.5)***

$0.61 (13.2)***

$0.55 (11.3)***

-$19,657 (2.1)**

-$21,079 (2.2)**

Ln ($Inherit) Inherit \$10 k

Ln (amt. saved) (4)

Ln (amt. saved) (5)

0.48 (3.5)***

0.43 (4.3)***

-0.31 (0.8)

-0.35 (0.9)

Income

$1.02 (12.1)***

$0.97 (11.0)***

$1.01 (11.2)***

2.6E-5 (11.4)***

2.4E-5 (9.5)***

White

$14,622 (1.6)

$3,698 (0.4)

$381 (0.1)

0.22 (4.9) ***

-0.25 (0.9)

Female

$3,523 (0.4)

$153 (0.1)

$1,826 (0.2)

0.21 (0.1)

0.27 (1.2)

Age

$2,407 (4.2)***

$1,826 (3.0)***

-$2,231 (1.8)*

0.06 (1.0)

-0.03 (0.9)

Married

$34,015 (3.0)***

$35,174 (3.0)***

1.50 (4.6)***

Family size Fulltime

$213 (0.1) -$12,261 (1.4)

$453 (0.1) -$19,983 (2.0)*

-0.19 (1.7)* 0.26 (0.9)

Spouse work

$6,354 (0.6)

$5,448 (0.6)

0.58 (2.1)**

Self employ

$1,600 (0.2)

$3,667 (0.3)

-0.18 (0.5)

High grade

$2,803 (1.8)*

$1,966 (0.8)*

0.13 (1.9)*

Years working

$340 (3.6)***

$1,558 (1.4)

0.07 (2.3)**

More educ.

$2,309 (0.2)

-0.99 (2.3)**

Changed job

-$4,572 (0.5)

-0.11 (0.5)

Got married

$38,900 (1.8)*

0.74 (1.2)

Got divorced

-$8,642 (0.3)

-3.45 (3.7)***

Had a child

-$895 (0.1)

-0.23 (0.6)

Num. siblings

$591 (0.3)

0.05 (0.9)

Net worth ‘85

-$0.01 (0.2)

-1.5E-6 (1.4)

Grade 1983

$2,564 (0.8)

-0.07 (0.8)

Time span

$20,105 (4.6)***

0.24 (2.0)**

Num. child

-$1,167 (0.3)

-0.06 (0.5)

Num. jobs Constant

-$101,443 (4.8)***

-$113,169 (3.5)***

-$1,110 (1.4) -$38,698 (0.9)

4.03 (3.5)***

-0.04 (1.8)* -2.46 (1.6)

Number obs.

8,073

8,073

7,781

8,073

7,781

R2

0.06

0.06

0.06

0.04

0.05

T-stat in () Regressions (1) to (3) explain total dollars saved. Regressions (4) and (5) explain the natural logarithm (base e) of dollars saved. ***, ** and * mean significant at 1, 5 and 10% levels. All financial variables adjusted for inflation into 2009 dollars. Data are from the 1985 to 2008 NLSY79

savings. Subtracting the bold faced coefficient from either $1.00 or 100% provides an estimate of how much the typical respondent spent out of their inheritance. Regressions were run by pooling NLSY79 data from 1985 to 2008

following Allison’s method (1995, p. 223), using just individuals who inherited. Regression (1) explains savings using only the most basic set of explanatory variables. This basic regression

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suggests that every dollar inherited by young baby boomers was associated with sixty-four cents of savings, after adjusting for income, race, gender, and age. While it is impossible to prove causation, the first regression suggests roughly one-third of inheritances were spent and two-thirds saved. Regressions (2) to (5) suggest that the basic regression results overestimate the amount saved. Regression (2) added a dummy variable that tracks if a respondent received a gift or inheritance less than $10,000.14 It also added other explanatory variables to track marital status, family size, employment characteristics, and educational attainment. Including these extra variables reduced the key inheritance coefficient to $0.61. Regression (3) expanded the list of explanatory variables by including variables which track changes from survey to survey to capture if changes in wealth were caused by life changes. The inclusion of these additional variables lowered the inheritance coefficient to $0.55. Regressions (4) and (5) used the natural log of the key financial variables. This alters the coefficient’s interpretation into percentage changes. Many financial values were either zero or negative and the natural log of these numbers is undefined. To handle this, individuals with a zero financial value were assumed to have $1. Individuals with negative values had the sign stripped off before taking the log and the negative sign replaced on the result, following Kennickell and Woodburn (1999). Regression (4), which had only the basic explanatory variables, suggests a 1% increase in inheritance was associated with a 0.48% increase in savings. Regression (5), which used the more extensive list of variables, suggests a 1% increase in inheritance was associated with a 0.43% increase in savings. Together the key coefficients in regressions (2)–(5) suggest the typical NLSY79 respondent retains about half of his/her inheritance and either spent or suffered capital losses for the other half. The regressions done in dollars suggest the savings figure was slightly above one half. The regressions done in natural logs suggest the savings figure was slightly below one half. Both functional forms provided roughly similar answers. To check on the results’ robustness additional tests, not shown, were run. For example, eliminating very large outlying values did not have an impact on the inheritance coefficients, but did roughly double the low R2 figures at the table’s bottom. A term tracking the square of the amount inherited was added but coefficients on this term 14

Graphically, the data suggest the savings-inheritance relationship was very different when low amounts are inherited compared to high. To search for the best place for a structural break a series of rolling Chow tests were used. The Chow tests reached their highest point of significance (F = 3.92) slightly above $10,000.

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were not statistically significant. Also, changing the financial figures from a household basis to a per person basis did not change the results significantly.

Discussion and Conclusion Do people save, splurge, spend, or snub their inheritances and large gifts? Data from the National Longitudinal Survey of Youth 1979 cohort (NLSY79) suggest but cannot prove that for roughly every dollar inherited, people save roughly one-half and either spend, donate, or lose the rest. These results fall partway between Joulfaian’s (2006) estimate of savings by the heirs of the very rich and Clotfelter and Cook’s (1990) estimate of savings by lottery prize winners. Readers are cautioned that the NLSY79 only covers people in their 20s, 30, and 40s. The experience of young baby boomers might not be representative of older Americans. National data covering all age ranges from the Survey of Consumer Finances (SCF) show that the median inheritor only receives about two-thirds of a year’s income. While the absolute amount is not large, neither is the fraction receiving (20.6%) or expecting to receive (14.2%) an inheritance. Congress must soon decide again what to do about the federal estate tax. The current estate tax rate and exemptions law are labeled ‘‘Temporary Estate Tax Relief’’ (U.S. Congress 2010) and expire at the end of 2012. When Congress revisits the estate tax laws it should also consider policies that boost savings of inherited wealth. One possibility is to change tax laws to cause heirs concerned about taxes to hold onto assets longer. Currently assets which are held at least 1 year qualify for lower longterm capital gains rates. Extending the long-term capital gains time frame to more than 1 year for all inherited assets or starting the tax clock based on when inherited assets are actually transferred to beneficiaries would make some heirs hold onto assets longer. Another possibility is to change the tax code for longterm savings accounts, such as IRAs. Currently, yearly contributions must come from earned income and are capped at relatively low amounts. For example in 2012 the maximum IRA contribution is $5,000 for people under 50 and $6,000 for people over 50. Congress could allow the estates of deceased people to contribute money into these long-term savings accounts without the need for inheritors to have earned income and at much higher amounts than the present maximums. Some inheritors will not like this idea since money taken out of an IRA is taxed at ordinary income rates instead of lower capital gains rates. However, many inheritors might find estate funded IRAs useful since inherited money grows tax free until withdrawn.


Additionally, moving inheritances into IRAs reassures many people by segregating money specifically for retirement and large early withdrawal penalties ensure much of the money put into these accounts stays there. This research asked, ‘‘do people save or spend their inheritances?’’ The answer is clear from at least one dataset: they spent about half of it. The U.S. has large numbers of wealthy elderly people who over the next 10 years will be transferring almost $4 trillion dollars to heirs. If the finding is correct this means about $2 trillion will be saved and $2 trillion spent. Is spending about half an inheritance good or bad? Since the money does not disappear from the economy, this is positive news for retailers, restaurant owners and people in the service industry. It is also good if this spending shifts money into the hands of more entrepreneurial individuals who use the money to hire workers and strengthen the economy. The spending is bad news for those concerned about the low U.S. savings rates, the financial destitution of many families and an inability of many individuals to delay gratification. These issues appeared in this research with some beneficiaries spending or losing their entire inheritance. The spending is also bad news for stock and bond prices. While it is impossible without making value judgments to say if spending about half an inheritance is good or bad, the result is important for educators, financial planners, and others who deal with heirs. Heirs should be asked what fraction of their inheritance they want to save. Heirs indicating they want to save a large fraction need to be warned that once given access to the money most people quickly spend or lose about half. Teaching potential heirs about the temptation to spend the money before the estate is distributed may encourage more of them to invest or save their inheritances.

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Author Biography Jay L. Zagorsky is a Research Scientist at The Ohio State University where he works at the Center for Human Resource Research. Since the mid 1960s the Center has run the National Longitudinal Surveys. Zagorsky extensively uses these surveys to understand personal financial matters. His research is widely quoted in the media. Jay Zagorsky earned his Ph.D. in Economics at Boston University. He continues to lecture at Boston University where he has taught over 70 courses to almost 5,000 students.