Made Poorer by Choice: Worker Outcomes in Social Security vs. Private Retirement Accounts
Board of Governors of the Federal Reserve System
Brad M. Barber
University of California, Davis
University of California, Berkeley - Haas School of Business
January 13, 2015
Can the freedom to choose how retirement funds are invested leave workers worse off? We analyze social risks of allowing choice, using the U.S. Social Security system as an example. Comparing a private account-based alternative with the current system via simulation, we document that choice in both equity allocation and equity composition lead to lower welfare, increased income inequality, and risk of shortfalls relative to currently promised benefits. While private accounts disproportionately increase shortfall risk for low-income workers, allowing choice increases risk for all workers (even with high return outcomes). Our results suggest that private-account-based systems featuring investor choice pose substantial risk to social welfare beyond that induced by uncertain market outcomes. We demonstrate that a representative worker (who earns his cohort’s average annual salary) benefits much more from a private-account alternative than do most workers. Thus, the welfare of such a representative worker should not be used to assess population-wide benefits of private account alternatives.
Number of Pages in PDF File: 51
Keywords: Social Security, Private Retirement Accounts, Behavioral Finance
JEL Classification: H55, J25working papers series
Date posted: October 1, 2012 ; Last revised: January 14, 2015
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