Life Cycle Theories of Savings and Consumption

The life-cycle hypothesis is closely related to the theory of work-leisure choice, which has been widely applied in the retirement literature. In the theory of work-leisure choice, individuals are assumed to maximize their utility derived from the consumption of goods and services, as well as from leisure. However, the consumption of goods and services requires income that, in turn, must be generated by earnings or savings. In this context, the retirement decision is based on the tradeoff between the utility gained from leisure time spent in retirement and the consumption of goods and services. Since retirement usually implies a substantial reduction of, or total absence of, wage income, the retirement decision is based on the point where an individual's savings accumulation has reached the level where it is sufficient to support the levels of consumption and leisure that maximizes his or her utility.