Retirement Savings: A Tale of Decisions and Defaults

Abstract

We examine the behavior of members of an industry-wide pension fund to assess both the prevalence of defaults and their impact on retirement savings. Our empirical investigations show that preferences, demographic characteristics and labor mobility matter greatly when it comes to the low active plan choice (or high defaulting) and overall level of pension benets. Using a structural dynamic life-cycle model, we then evaluate the ability of these empirically motivated factors to explain retirement savings patterns. In our model, individuals decide how much to save in a setting that combines an irreversible automatic enrolment with an active decision regime. After automatic enrolment, there is an initial choice between two pension plans (defined benefit vs. defined contribution), and then members decide (possibly by default) their voluntary contributions and type of investment allocation. We estimate the model using the simulated method of moments on administrative data from a large Australian pension fund. Our results show that default settings strongly influence wealth accumulation. Such settings are also highly persistent, both over time and across decisions. Overall, our findings suggest that if defaults (particularly the irreversible ones) are not carefully designed, retirement savings can be severely affected.

Keywords: pension defaults, retirement savings, method of moments

JEL Classification: H8, J26, J32