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Defined Benefit or Defined Contribution? A Study of Pension Choices

Authors


  • Paula Lopes gratefully acknowledges financial support of the Financial Markets Group (RTN Project on Financing Retirement in Europe and the UBS Pensions Research Programme). We would like to thank John Y. Campbell, Georges Dionne, David Goldreich, Francisco Gomes, Jean Hindricks, Joachim Inkmann, Alexander Michaelides, Michael Orszag, two anonymous referees, and seminar participants at the University of Amsterdam, University of California at Berkeley, University of Maastricht, London Business School, Warwick University, and the 4th RTN Workshop on Financing Retirement in Europe for comments. We would like to thank the UK Data Archive for making the data available.

Abstract

We solve an empirically parameterized life-cycle model of consumption and pension choices to show how expected earnings growth and risk affect the benefits of final-salary defined benefit (DB) pension plans, relative to pension plans that are defined contribution (DC) in nature. We use micro data on the pension choices of individuals to provide evidence consistent with the model predictions: (1) individuals who expect a higher growth rate of earnings are more likely to choose DB final-salary schemes, and (2) individuals who face a higher variance of persistent income shocks are less likely to choose DB final-salary schemes. We control for cohort and age fixed effects in the empirical analysis.

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