Hyperbolic discounting with naiveté is widely believed to provide a better explanation than exponential discounting of why people borrow so much and why they wait so long to save for retirement. We reach a different set of conclusions. We show that if financial planning is enriched to include the choice of when to retire, then naïve hyperbolic discounters may borrow far less and start saving for retirement significantly earlier than exponential discounters.
ZINA LEKNIUTE, University of Amsterdam
ROEL M. W. J. BEETSMA, University of Amsterdam - Research Institute in Economics & Econometrics (RESAM), Centre for Economic Policy Research (CEPR), CESifo (Center for Economic Studies and Ifo Institute), Tinbergen Institute - Tinbergen Institute Amsterdam (TIA), Netspar
EDUARD H.M. PONDS, Algemene Pensioen Groep (APG), Tilburg University - Department of Economics, Netspar, Tilburg University - Center for Economic Research (CentER)
This paper explores the financial sustainability of a typical U.S. state defined-benefit pension fund under the continuation of current policies and under alternative policies, such as alternative contribution, indexation and investment allocation policies. We explore the "classic" asset-liability management (ALM) results, which indicate that a policy of conditional indexation may substantially improve the financial position of the fund. We also investigate the value-based ALM results, which provide a market-based evaluation of the net benefits of the contract to the various stakeholders. All participant cohorts under our simulation horizon derive a substantial net benefit from the pension contract, implying that tax payers make substantial contributions to this pension arrangement. The aforementioned measures can be instrumental in alleviating the burden on the tax payer, though this will happen at the cost of a reduction in the value of the contract to the participants.
The United States is facing a retirement crisis, in significant part because defined benefit pension plans have been replaced by defined contribution retirement plans that, whatever their theoretical merit, have left significant numbers of workers unprepared for retirement. A troubling example of the continuing movement away from defined benefit plans is a new phenomenon euphemistically called “pension de-risking.”
Recent years have been marked by high-profile companies engaging in various actions designed to reduce the company’s exposure to pension funding risk (hence the term “pension de-risking”). Some de-risking strategies convert a federally-guaranteed pension into a more risky private annuity. Other approaches convert the pension into cash for the beneficiary, which may be insufficient to provide lasting retirement income. These strategies have raised many concerns that participants are getting the short end of the stick and that pension de-risking is undermining the statutory purpose of ERISA.
Regulators are only beginning to consider ways to appropriately police pension de-risking behavior. We propose that the government should take an aggressive stance in regulating such conduct. Participants as a class should not be made worse off by a pension de-risking transaction, and the relevant de-risking rules should so reflect. More specifically, regulators should (1) encourage desirable forms of de-risking by establishing regulatory safe harbors; (2) require a battery of procedural safeguards for annuitization transactions; (3) require improved disclosures for cash buyouts; and (4) limit cash buyouts when beneficiaries are not likely to meaningfully understand the potentially adverse consequences of trading a pension for cash.
STEVEN A. SASS, Boston College - Center for Retirement Research
ANEK BELBASE, Center for Retirement Research at Boston College
THOMAS COOPERRIDER, Berkeley Research Group,LLC
JORGE D. RAMOS-MERCADO, Center for Retirement Research at Boston College
Subjective financial assessments are used by social scientists as a measure of financial well-being and by households as the basis for action. Financial well-being, however, increasingly requires workers to build-up savings to meet hard-to-see future needs, specifically retirement, their children’s education, and paying off student loans.
This paper analyzes data from the FINRA Investor Education Foundation’s 2012 Financial Capability Survey to test whether subjective financial assessments 1) primarily reflect day-to-day, rather than distant, financial concerns; 2) increasingly reflect distant concerns if the household’s day-to-day finances are in reasonably good shape; and 3) increasingly reflect distant concerns if the worker is financially literate.
The paper found that:
* Subjective financial assessments primarily reflect day-to-day conditions.
* This remains the case even if the household’s day-to-day finances are in reasonably good shape.
* Financial literacy enhances sensitivity to the lack of a retirement plan and having a mortgage greater than the value of one’s house, but it has no noticeable effect on sensitivity to life and medical insurance deficits, having an inactive retirement plan, not saving for college, or student debt burdens.
The policy implications of the findings are:
* Subjective financial assessments have become a poor measure of financial well-being.
* Workers by themselves cannot be expected to devote much effort to addressing distant deficits.
* Initiatives to improve well-being must raise awareness – or compensate for the lack of awareness – of hard-to-see distant future deficits.