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Risky Pensions and Household Saving Over the Life Cycle

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  • David A. Love
  • Paul A. Smith

Abstract

Recent defined benefit (DB) pension freezes in large healthy firms such as Verizon and IBM, as well as terminations of plans in the struggling steel and airline industries, highlight the fact that these traditional pensions cannot be viewed as risk-free promises from the employee's perspective. In this paper we develop an empirical dynamic programming framework to investigate household saving decisions in a model economy with risky DB pensions. The model incorporates important sources of uncertainty facing households, including asset returns, employment, income, and mortality, as well as pension freezes. Applying a compensating variation measure of welfare, we find that pension freezes reduce welfare by a maximum of about $6,000 for individuals with a high school degree and about $2,000 for individuals with a college degree.

Suggested Citation

  • David A. Love & Paul A. Smith, 2008. "Risky Pensions and Household Saving Over the Life Cycle," Working Papers, Center for Retirement Research at Boston College wp2008-19, Center for Retirement Research, revised Dec 2008.
  • Handle: RePEc:crr:crrwps:wp2008-19
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    File URL: http://crr.bc.edu/working-papers/risky-pensions-and-household-saving-over-the-life-cycle/
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    References listed on IDEAS

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    1. Love, David, 2006. "Buffer stock saving in retirement accounts," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1473-1492, October.
    2. David I. Laibson & Andrea Repetto & Jeremy Tobacman, 1998. "Self-Control and Saving for Retirement," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 91-196.
    3. Jeffrey R. Brown & James M. Poterba, 1999. "Joint Life Annuities and Annuity Demand by Married Couples," NBER Working Papers 7199, National Bureau of Economic Research, Inc.
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