Planning and Saving for Retirement

Abstract

Planning for retirement and subsequent execution of the plan are difficult, but essential for financial security in old age. To formally analyse the interplay between planning and self-control, I introduce cognitive costs of formulating a plan into the two-system model of impulse control. The resulting possibility of rational inaction in pension choices allows to account for a range of robustly observed behaviours. The model indicates that although automatic enrolment into private pensions raises participation (the `default option effect'), its impact on aggregate savings remains ambiguous as some individuals are `forced' to save, while others become `discouraged' and adhere to possibly low default contribution rates. Due to the same mechanism, automatic enrolment reduces cross-agent variation in wealth accumulation. A simple calibration of the model to the UK data shows that while automatic enrolment can increase aggregate savings, its impact on welfare is limited because age-independent contribution rates are suboptimal from the perspective of life-cycle consumption smoothing. Importantly, the effects on savings and welfare are highly heterogeneous across income categories.