Lessons from Behavioral Finance for Retirement Plan Design [chapter]

Olivia S. Mitchell, Stephen P. Utkus
2004 Pension Design and Structure  
This paper evaluates some of the key lessons of behavioral economics and finance research over the last decade for pension plan design. We divide the discussion into the natural phases of the retirement saving life cycle: accumulation, investment, and decumulation. After reviewing the lessons of behavioral finance, we conclude by outlining plan design alternatives that would be of use to plan sponsors and policymakers seeking to design more cost-effective and efficient retirement plans for the
more » ... ment plans for the future. Participant-directed defined contribution (DC) plans have become the cornerstone of the privatesector retirement system around the world. In the U.S., participant choice has spread not only to pensions, but to a great many other aspects of the employee benefit package as well including health care plans, flexible benefit programs, and time-off arrangements. The trend toward giving participants more choice also underlies recent proposals to reform Social Security by adding personal accounts, and Medicare proposals to permit seniors to choose whether they want a public versus a privately-managed healthcare plan. Participant-managed DC plans are the main feature of national pension reforms already implemented in many Latin American nations, as well as in Germany, Sweden, and most recently, Russia. Underlying this global movement spurring participant choice is an implicit assumption about behavior: that the employee-citizen to whom the responsibility of choice has been handed is a wellinformed economic agent who acts rationally to maximize his self interest. To this end, it is assumed that he can interpret and weigh information presented regarding options offered by employers and governments, appropriately evaluate and balance these choices, and then make an informed decision based on a weighing of the alternatives. Recently, however, a different perspective has emerged regarding how "real" people make economic decisions, one developed by social scientists working at the interface of economics, finance, psychology, and even sociology. This perspective is consistent with the fundamental economic proposition that people can and do try to maximize their self-interest, but it also recognizes that such decisions are often made with less-than perfect outcomes. In the real world, peoples' decisions are subject to "bounded rationality," as the Herbert Simon called it (Simon, 1955) . Certain types of decisions and problems may be simply too complex for individuals to master on their own. There is also what Mullainathan and Thaler (2000) call "bounded self-control"-individuals have the right intentions or
doi:10.1093/0199273391.003.0001 fatcat:dckdvc6slvdhhipr6qggc4exae