Optimal Defined Contribution Pension Plans: One-size Does Not Fit All

Erik Öberg, Tobias Broer, Jeppe Druedahl, Karl Harmenberg

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

We study the role of defined contribution pension plans for individuals’ welfare and ability to accommodate shocks. Using a rich life-cycle model, we find that common designs, with a fixed contribution rate out of income for all individuals at all times, are unnecessarily rigid. We propose a design where the contribution rate is a function of the individuals’ age and account balance-to-income ratio. Compared to the typical rigid contribution rate, our design leads to the same average replacement rate, 25.6 percent, but reduces the cross-sectional standard deviation from 10.8 to 4.0 percent. Furthermore, our proposed rule provides both liquidity and consumption benefits for the first 17 years. Consumption increases by as much as 4.9 percent. The design implies a welfare gain of 3.3 percent in consumption equivalent relative to the current fixed contribution rate.
Original languageEnglish
Publication date2021
Number of pages37
Publication statusPublished - 2021
Event2021 Annual Meeting of the Society for Economic Dynamics - Zoom hosted by University of Minnesota, Minneapolis, United States
Duration: 1 Jul 20213 Jul 2021
https://www.economicdynamics.org/sedam_2021/

Conference

Conference2021 Annual Meeting of the Society for Economic Dynamics
LocationZoom hosted by University of Minnesota
CountryUnited States
CityMinneapolis
Period01/07/202103/07/2021
Internet address

Keywords

  • Age-based investing
  • Life-cycle model
  • Pension plan design

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