Optimal Retirement Savings Over the Life Cycle: A Deterministic Analysis in Closed Form

Marcel Fischer, Bjarne Astrup Jensen*, Marlene Koch

*Corresponding author for this work

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Abstract

In this paper, we explore the life cycle consumption-savings problem in a stylized model with a risk-free investment opportunity, a tax-deferred retirement account, and deterministic labor income. Our closed form solutions show that liquidity constraints can be severely binding; in particular in situations with a high growth rate of labor income, in which retirement saving is optimally postponed. With a tax-deferred account, it is always optimal to save in this (illiquid) account first before saving in the (liquid) taxable account in order to satisfy the needs for consumption smoothing. The optimal retirement savings pattern is far from the widespread practice of contributing a fixed fraction of current labor income over the working life to a tax-deferred environment.
Original languageEnglish
JournalInsurance: Mathematics and Economics
Volume112
Pages (from-to)48-58
Number of pages11
ISSN0167-6687
DOIs
Publication statusPublished - Sept 2023

Keywords

  • Retirement saving
  • Tax-deferred investing
  • Borrowing constraints
  • Labor income
  • Analytical solution

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