Savings, from the perspective of the individual, comprises money set aside for future use. Savings, from the perspective of the economy, includes all of the money set aside by all individuals, employers, governments, and other groups. Savings are important to the individual because they enable people to make purchases in the future and to be prepared for unforeseen financial needs. Savings are important to the economy because they allow investment to occur: one person or organization uses the savings of others to finance the making of a movie, to construct a home or building, or for other uses. If a person did not save, then he or she would not be able to borrow money to purchase a home.
For the individual, money to be saved may be placed in a piggy bank; put under a mattress; placed in a savings account or a certificate of deposit at a bank or savings and loan; or invested in a U.S. Savings Bond, a home, a stock or a bond, or some other asset that can later be sold or cashed in. When savings are put in a piggy bank or under a mattress the money is not available for others to use, and is therefore not helpful to the economy, even though it will be available for the individual to use. When savings are deposited in a bank account, the depositor is normally paid for use of the money in the form of interest. Generally, an individual can assume that he or she will get back the money deposited plus the interest income. This money is then loaned to someone else who is willing to pay even higher interest to the intermediary, such as a bank. When savings are invested, an individual generally hopes to earn more than would be provided by an interest payment from a savings account, but has the potential of earning nothing, or of actually losing the money that was invested. This is what happens if an individual invests in a share of stock valued at $100, and then has to sell it at $50. This can also happen with a home or any other investment.
When viewed from the individual perspective, savings are described as being at the micro level—that is, the primary impact is on the individual. Savings from the perspective of the economy, are described as being at the macro level— that is, the cumulative effect of what everyone does is considered. At the micro level, for example, those who have savings may feel secure; but if many individuals do not have savings, then there may be no macro savings in the economy.
The economy needs savings so that the money can be borrowed by others, allowing investment and growth. Individuals save so that they can spend in the future without having to borrow as much, or any, money from others. A child may save to purchase a bike; a young adult may save for a first car; and a newly married couple may save for a first home. All workers save so that they can someday stop working and still have money to live on.
How is savings measured?
Saving is measured in different ways, which frequently leads to confusion. One measure is the National Income and Product Accounts (NIPA), produced by the Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce. Another is the Flow of Funds Accounts (FFA), produced by the board of governors of the Federal Reserve System. The news media typically cite the NIPA measure, and not the FFA measure. This can lead to a feeling among individuals that they have growing savings, even though the papers say that people are not doing well at saving.
NIPA. Under NIPA, personal savings is a residual. This means that personal savings is what is left over from personal income after subtracting payments for personal income taxes, individual payroll taxes (i.e., individual contributions for Social Security and Medicare), and all other personal outlays, such as food, housing, and clothing expenditures.
Personal income includes the following:
- Wages and salaries
- Other labor income (i.e., employer contributions to pensions and profit-sharing plans, group insurance, such as health, workers’ compensation, and supplemental unemployment coverage)
- Rental income
- Personal dividend income
- Personal interest income
- Transfer payments (i.e., Social Security benefit payments, government unemployment and insurance payments, veterans benefits, government employees retirement benefits, and welfare payments)
Personal taxes include the following:
- Federal income tax payments
- State and local income tax payments
- Any penalties, fines, or interest payments made on income tax statements
- Contributions to social insurance programs (i.e., Social Security and Medicare payroll taxes)
Personal outlays include the following:
- Personal consumption expenditures (i.e., spending on food, housing, clothing, household operations such as utility bills, transportation, and medical care)
- Consumer interest payments (i.e., payments of credit card interest)
- Personal transfer payments to persons located outside the U.S. are treated as outlays, whereas transfers among persons within the U.S. are not
Disposable personal income equals personal income after deducting personal income taxes and payroll taxes, but before personal outlays are deducted. Personal savings is what is left over from disposable personal income after deducting personal outlays. Personal savings divided by disposable personal income is the personal saving rate. For the individual, this rate is the measure of how much was saved in a particular month.
FFA. Whereas NIPA measures personal savings as a residual, the FFA personal saving rate is a direct measure of the net acquisition of assets by households. FFA methodology differs from that used by NIPA in two ways: (1) in the treatment of consumer durables and (2) in the definition of personal income.
The FFA treats the net acquisition of consumer durable goods (i.e., automobiles, major household appliances, and other products that can be used for several years) as a form of saving, whereas the NIPA treats expenditures on consumer durables as a component of personal consumption. The FFA also makes some adjustments to the NIPA measure of personal income: The FFA includes certain credits from government insurance programs and realized capital gains distributions, whereas NIPA does not. (It is important to note that neither FFA nor NIPA includes unrealized capital gains.) For example, if an individual purchases ten shares of corporate stock at $10 a share, and the stock then increases to $30 a share, the increased value of the stock is not considered part of personal income under FFA until the individual sells the stock and realizes the capital gain. By contrast, under NIPA the increased value of the stock is never considered part of personal income.
For the individual this means that how much is saved is derived from a broader definition of income (wages or salary, plus interest income, plus gains from the sale of a house or stock), but with some of what one might have spent actually counted as saving (i.e., appliances, automobiles, etc.) even though one won’t be able to sell what was bought for the amount paid.
Implications. Neither NIPA nor FFA calculate savings the way most individuals think of it on a day-to-day basis. The individual looks at what is being saved now (the $500 just put into a savings bond), as well as the growth of what was saved before (how much did my 401(k) account go up this quarter), and thinks about savings as accumulated wealth. The individual does not generally think about a credit-card balance or a home mortgage as negative savings, meaning that if they charged $1,000 and put $500 into a savings account, they are likely to still say they saved $500.
NIPA and FFA, using different methods, add transactions together to get net figures. This is what the mortgage applicant does when filling out a ‘‘net worth’’ statement so that the bank can see how much ‘‘net’’ savings a person actually has.
Individuals who owned equities during the 1990s generally experienced tremendous increases in the value of those financial assets (i.e., they became wealthier). According to data from the Federal Reserve’s Survey of Consumer Finances (SCF), the net worth (the difference between a family’s gross assets and liabilities) of the typical American family (i.e., median net worth) rose 17.6 percent between 1995 and 1998—from $60,900 to $71,600. This increase in net worth was driven by strong growth in the financial assets held by families, especially direct and indirect holdings of stocks. As of 1998, 92.9 percent of American families held some type of financial asset, and the median value of assets, among those with financial assets, was $22,400 (comparable figures for 1995 are 91.0 percent and $16,500, respectively) (median means midpoint or 50 percent above and 50 percent below). Almost one-half (48.8 percent) of families held stock (directly or indirectly) in 1998, compared with 40.4 percent in 1995, and 31.6 percent in 1989. The median value of stock among families with holdings increased from $10,800 in 1989 to $15,400 in 1995, and to $25,000 in 1998. Over the same period, stock holdings as a share of families’ financial assets increased from 27.8 percent in 1989 to 40 percent in 1995, and to 53.9 percent in 1998.
One could argue that a more complete measure of saving would include increased wealth through capital gains (both realized and unrealized) as part of personal income. As mentioned above, FFA includes realized capital gains in its measure of saving, but not unrealized capital gains.
William Gale and John Sabelhaus (1999) identified other shortcomings, in addition to the exclusion of accrued and realized capital gains from income—and thus from savings—in the NIPA measure of saving. Among these shortcomings are:
- While net acquisition of owner-occupied housing is considered saving, net acquisition of other consumer durables is counted as current consumption, not saving
- Nominal (as opposed to just the real component of) interest receipts are counted as income, whereas nominal interest payments are counted as outlays
- NIPA does not factor in the implicit tax liability of saving in tax-qualified plans
Tax incentives for savings
Since 1926 the Internal Revenue Code has provided for deferral of taxes on retirement savings in plans that file with the government to be ‘‘qualified’’ for this special tax treatment. Contributions to such plans are not taxed as income when made, and interest and investment gains are not taxed when realized. Instead, both are taxed upon withdrawal from the plan. Many such incentives have been added to the law since 1926. Not all are for retirement savings, with incentives now offered for saving towards the purchase of a new home, saving for sending children to college, or saving for medical expenses.
The savings issue that arises when such incentives are discussed, is the impact of such incentives (in particular, IRAs and 401(k) plans) on personal saving rates. At the aggregate level, tax-qualified retirement plans represent a tremendous store of wealth in vehicles earmarked specifically for retirement—$10.5 trillion as of 1998, up from $3 trillion just one decade earlier. At the individual level, the latest data on 401(k) accumulations indicate the potential these vehicles have for generating retirement wealth. According to the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project, the average 401(k) account balance was $55,000 at year-end 2000 (up 47 percent from the average account balance at year-end 1996). More significantly, the average balances of older workers with long tenure indicate that a mature 401(k) program will produce substantial account balances. For example, individuals in their 60s with at least 30 years of tenure have average account balances in excess of $185,000.
Some argue that the tax-preferred treatment and the implicit government subsidy of saving through such plans, along with the provision of a degree of self-discipline that results from automatic saving, results in higher levels of saving than would otherwise exist without such programs. Others maintain that such preferential tax treatment merely serves as an inducement to transfer existing savings into such vehicles or to use such vehicles for saving that would have occurred even without such programs.
Interest in this issue is spurred by the fact that individual tax deferrals for employer-based retirement plan contributions and earnings carry a high estimated cost to the federal government, relative to other programs. The U.S. Treasury Department estimates that in fiscal 2000, the net exclusion of pension contributions and earnings will result in a federal tax revenue loss of $99.8 billion, and for fiscal years 2000 through 2004, these provisions will result in a tax revenue loss of $527.2 billion over the five-year period (see Executive Office of the President 1999). One analysis (Salisbury 1993) found that about one-half of the retirement-tax preference was attributable to public-sector-defined benefit retirement plans, about one-third to private-sectordefined contribution plans, 15 percent to private-sector-defined benefit plans, and 2 percent to public-sector-defined contribution plans.
Impact on savings. James Poterba, Steve Venti, and David Wise (1996), based on a body of research that they conducted over time, concluded that contributions to tax-qualified personal-retirement savings plans (IRAs and 401(k) plans) represent largely new savings and thus such plans have a significant positive effect upon saving rates.
Steven Venti and David Wise (1995), utilizing the Survey of Income and Program Participation (SIPP), and based on a household longitudinal methodology, found no significant reduction in other saving when households begin contributing to IRAs.
What would households eligible for saving incentives have saved in the absence of these incentives? Eric Engen, William Gale, and Karl Scholz (1996) argue that empirical analysis of this question is difficult and subject to biases that generally lead to overestimation of the impact of saving incentives. They conclude, based on a body of empirical work, that controlling for these biases largely or completely eliminates estimated positive effects of saving incentives on saving. They do qualify this conclusion by stating that such incentives may increase saving for some people and that they may eventually increase saving in the long run.
Are people saving enough to retire?
Another major policy issue is whether current workers are saving enough for their retirement, in particular the post-World War II baby boom generation (those born between 1946 and 1964). The Employee Benefit Research Institute (EBRI) hosted a policy forum on this topic in 1994 (see Salisbury 1994) and subsequently published an issue brief on retirement saving adequacy (see Yakoboski and Silverman, 1994). This section updates that material.
According to the 1999 EBRI Retirement Confidence Survey (RCS), 74 percent of workers say they have established an investment or savings program for their retirement, and 70 percent report they are personally saving money for retirement—an increase from the 63 percent who reported saving for retirement in 1998. However, the amounts accumulated are generally unimpressive. The median amount accumulated for retirement by all households was $29,514. While the median amount saved increased by age (ages 25–39, $20,588; ages 40–49, $45,238; ages 50–59, $71,250), working households of individuals age sixty and older accumulated less ($39,286)—perhaps because they are more likely to expect to rely on Social Security for a major portion of their retirement income. To put these accumulations in perspective, suppose a single male, age 65, purchased a life annuity in 2001. With $71,250, he could have purchased a nominal monthly annuity for life of $631; while with $39,286, he would have gotten a monthly annuity of only $348.
What is clear is that even though most workers and households are saving for retirement, relatively few have a good idea of how much they need to save. In 1999, 52 percent of all households reported in the RCS that they had tried to figure out how much money they will need to have saved by the time they retire so that they can live comfortably in retirement (among households that have saved for retirement the figure was 61 percent). So while most people may be saving for retirement, they appear to be simply assuming (or hoping) that they will accumulate enough. Given the upward trend in life expectancies of individuals once they reach age 65 (and projections of future growth in these life expectancies), hoping and assuming will likely not be good enough in light of retirements that could span decades.
On average, those who have done a needs calculation have saved considerably more than those who have not done the calculation. The 1999 RCS found that the median amount accumulated by households that have tried to figure out how much money they will need in retirement is $66,532, compared with a median of $14,054 accumulated by those who have not done the calculation. Planning, therefore, plays an important role in explaining the saving behavior of many households.
The 1999 Retirement Confidence Survey found that 57 percent of workers who are not currently saving for retirement say it is reasonably possible for them to save $20 per week for retirement. In addition, 69 percent of workers who are already saving report that it is possible for them to save an additional $20 per week (see Ostuw, Pierron, and Yakoboski 1999). Saving $20 per week amounts to more than $1,000 per year, which, over time, can add up to a significant sum of money. The power of compound interest allows a twenty-five-year-old saving $20 a week, assuming a 5 percent annual real rate of return over forty years, to accumulate a retirement nest egg worth nearly $132,000. With a 10 percent annual real rate of return, $20 a week saved over forty years can accumulate to more than $500,000.
Concerns about low levels of aggregate personal saving at the national level appear misplaced. Americans—in the aggregate—are saving. That saving, however, is partially the result of large capital gains that have been experienced in the financial markets over recent years. Since NIPA, the most commonly cited measure of personal saving, does not factor capital gains (neither realized nor unrealized) into income, the saving rate appears to have dropped dramatically over the past decade. Accounting for capital gains changes the picture dramatically, however. By one measure, aggregate personal saving is 33 percent of ‘‘income’’ and has increased dramatically over the past decade. However, while there may not be an aggregate ‘‘saving crisis’’ per se, a note of caution is warranted: To the degree that aggregate personal saving is driven by a bull market in equities, as in the 1990s, a sharp contraction in the equities market could have potentially drastic consequences.
Also, while the rate of aggregate personal saving may be healthy at the national level, this does not mean that fears about inadequate retirement preparations among current workers are misplaced. While sweeping generalizations are to be avoided, and while some workers are on track for adequate retirement savings, the evidence indicates that many groups of American workers appear unlikely to be able to afford a retirement that maintains their current lifestyle (at least not without working more years than currently planned). Consensus does not exist on how many workers are at risk, or on the typical magnitude of their retirement savings shortfall. There is a consensus, however, that a substantial number of individuals are at risk. This is not surprising—despite the fact that the 70 percent of workers are saving for retirement—since relatively few workers know how much it is that they need to accumulate to fund their retirement.
One question yet to be addressed is whether and how retirement assets will be affected by the ever-growing initiatives in Congress to expand tax-deferred savings accounts for nonretirement purposes (such as education, health care, job training, and other costs). As the options grow among tax-deferred savings accounts, or as Congress passes new laws relaxing the tax penalties for using retirement account assets for nonretirement purposes, the competition for retirement savings is certain to grow—and this growth is likely to occur just when the demographic wave of Americans reaching retirement age is starting to crest.
Issues regarding saving levels and the adequacy of retirement preparations will continue to capture the attention of policymakers, the news media, and the public as the baby boom generation moves toward its retirement years. This is most evident with Social Security, as changes needed to ensure the long-term financial viability of the system are debated. Many reform proposals involve elements designed to give workers their own individual retirement savings accounts through the Social Security system.
Education efforts related to saving and financial literacy now abound because the data says that those who get such education begin to save, to increase what they save, and to invest on a more diversified basis.
At one level, success has already been achieved: 70 percent of American workers report that they have begun to save for their retirement. However, this still means that 30 percent (disproportionately younger and lower-earning individuals) are not in the retirement savings game at all. These individuals likely do not appreciate the difference that even seemingly small amounts of money saved on a regular periodic basis can make over time. For the nation, a higher bar to strive for is not merely to create savers, but rather to create planners who can develop a specific dollar goal for their retirement and then save accordingly. On this latter point, there remains plenty of room for improvement, and this goal would seem to be the next crucial step to ensuring individual retirement-income security for American workers.
See also Annuities; Assets and Wealth; Bequests and Inheritances; Financial Planning for Long-Term Care; Individual Retirement Accounts; Life Cycle Theories of Savings and Consumption; Pensions, Plan Types and Policy Approaches; Retirement Planning; Retirement Planning Programs.
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Savings are the amount of income left after a consumer has finished making personal expenditures and paying taxes. People save to pay for retirement, education, or vacations. They usually put their savings into bank savings or checking accounts, invest them in securities like stocks or mutual funds, or keep savings as cash. The percentage of personal income that people save depends on how optimistic they are about their future income, their own personal inclination to spend now or "save for a rainy day," and the amount of interest or return they expect to get by saving or investing.
Economists generally regard saving as good because the economy can only grow if some consumers refrain from consuming and instead invest in the factories and equipment that enable companies to expand production. However, in a phenomenon called "the paradox of thrift," economists have also shown that when economic growth is threatened by weak demand, too much saving will actually result in slower economic growth because consumers will be buying less.
The amount of income that people in the United States save has varied significantly throughout the twentieth century. During the Great Depression (1929–1939) for example, consumers needed all their income for necessities—saving rates were consequently negative. During World War II (1939–1945), however, government rationing and savings bond drives encouraged people in the United States to save. By 1944 U.S. citizens were saving 25.7 percent of their incomes— the highest savings rate in the century. In the postwar years, U.S. citizens have saved less and less. By 1981 consumers were saving only 9.4 percent of their incomes; by 1989 only 5.1 percent, and by 1997 only 3.8 percent—the lowest rate since the Depression. To encourage U.S. citizens to save more, Congress created Individual Retirement Accounts (IRAs) in 1982. IRAs did encourage consumers to invest more, but the savings rate continued to fall because easy-to-obtain credit cards and low home mortgage down payments enabled consumers to buy homes and other goods without first saving for them.
By the late 1990s some economists estimated that U.S. consumers were saving only a third of what they needed to maintain their standard of living in retirement. As the twentieth century ended, politicians debated several solutions for increasing national savings, including scrapping the income tax system in favor of a flat tax or a national sales tax and creating governmentsponsored "Universal Savings Accounts" that would let U.S. citizens invest part of their taxes in mutual funds or bonds.
See also: Investment
thrift / [unvoicedth]rift/ • n. 1. the quality of using money and other resources carefully and not wastefully: the values of thrift and self-reliance. ∎ another term for savings and loan. 2. a European plant (Armeria maritima, family Plumbaginaceae) that forms low-growing tufts of slender leaves with rounded pink flowerheads, growing chiefly on sea cliffs and mountains.