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Designing Pension Plans According to Consumption-Savings Theory

Author

Listed:
  • Schlafmann, Kathrin
  • Setty, Ofer
  • Vestman, Roine

Abstract

We derive optimal characteristics of contribution rates into defined contribution pension plans based on consumption savings theory. Contribution rates should be age-dependent and adjust to the balance-to-income ratio. Using detailed registry data on household savings behavior in Sweden we show that individuals adjust savings rates according to these principles. We apply these principles in a quantitative model to design an optimal rule for contribution rates in a mandatory defined-contribution pension plan. Compared to typical rigid designs of contribution rates, our proposed design leads to the same average replacement rate and provides liquidity benefits and insurance against income shocks. The design implies a welfare gain of 1.8 percent in consumption equivalent and reduces the dispersion of replacement rates by more than 40 percent. Our design is robust to time-inconsistent investors.

Suggested Citation

  • Schlafmann, Kathrin & Setty, Ofer & Vestman, Roine, 2022. "Designing Pension Plans According to Consumption-Savings Theory," CEPR Discussion Papers 17489, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17489
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    More about this item

    Keywords

    Age-based investing; Life-cycle model; Pension plan design;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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