Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY.
• Choice of retirement age
Choice of retirement age
• Steepness of I-curve
– reflects willingness to postpone retirement for
additional income.
• Steepness of budget constraint determined by
– earnings profile
– Social Security formula
– pension plan features
• Pure Wealth effect would result from a parallel
shift of budget constraint (e.g. win lottery, inherit
money)
• Wealth and substitution effect would result if
slope of budget constraint is altered.
Choice of retirement age
• If the financial rewards to postponing retirement
beyond age 62 are increased, the person with is
faced with a wealth and substitution effect.
• Wealth effect: Holding retirement age constant,
the person has greater wealth and will retire
sooner.
• Substitution Effect: Holding wealth constant,
the reward to postponing retirement has
increased .. substitute money for years in
retirement.
• Net effect: Ambiguous.
Choice of retirement age
• Effect of increasing rewards to postponed retirement
subst efffect >
Wealth effect
Wealth effect >
subst efffect
R*
Choice of retirement age
How do each of the following affect retirement age?
• steepness of earnings profile?
• Social Security formulae
• Calculating AIME & PIA
• reductions for early retirement
• credits for postponed retirement.
Choice of retirement age
Private pensions
•Defined benefit plan
• life annuity promised at retirement.
• annuity payment generally tied to years of service, final salary, and
a "generosity factor".
• PV of defined benefit plan may eventually fall with retirement age
(fewer years to collect annuity versus increase in size of annuity).
• “Actuarially fair” adjustment for postponing retirement by one year
keeps PV of pension independent of retirement age.
• If life expectancy is 80, what is actuarially fair adjustment for a
worker who collect an annuity of $50,000 annually at age 65,
assuming interest rate=0? If interest rate>0?
Choice of retirement age
Private pensions
•Defined Contribution Plan.
•a savings account that the worker may receive as a lump sum at
retirement.
• PV of defined contribution plan grows with retirement age because
contributions are added over time.
• Over time, there has been a switch from defined benefit to defined
contribution plans.
• What's the effect of switching from DB to DC plans on retirement
incentives?