Abstract

Recent empirical evidence shows that the death of a first spouse in retired couples leads to a sharp decline in wealth, reflecting not only reduced income but also additional transfers to heirs outside the couple. Such ‘side’ bequests have significant financial consequences for a surviving spouse, but the existing literature on financial decision-making does not account for them. To fill this gap, we build a model for optimal life insurance, consumption and portfolio decisions of a retired couple, with side bequest motives. Using analytical results and numerical simulations, we show that side bequests substantially alter couples’ optimal life insurance and consumption decisions. In particular, we show that life insurance is an important tool that allows couples to balance their side bequest motive with the utility of a surviving spouse. Our model, therefore, highlights the importance of accounting for side bequests when making these decisions: