Heuristics and Biases in Retirement Savings Behavior

A ll around the world, in both the public and private sectors, retirement plans are shifting away from “defined benefit” plans toward “defined contribution” plans. Poterba, Venti, and Wise (2006), for example, followed the cohort of Americans who were 45 years old in 1984 and report a decrease in defined benefit plan coverage from about 40 percent to 20 percent and a corresponding increase in defined contribution plan coverage from about 5 percent to more than 30 percent. Defined contribution plans have many attractive features for participants, such as portability and flexibility, but these attractions come with an increased responsibility to choose wisely. The plans also provide economists with an attractive domain in which to study saving behavior. The standard economic theories of saving (like the life-cycle or permanent income models) contain three embedded rationality assumptions, one explicit and two implicit. The explicit assumption is that savers accumulate and then decumulate assets to maximize some lifetime utility function (possibly including bequests). The first implicit assumption is that households have the cognitive ability to solve the necessary optimization problem. The second implicit assumption is that the households also have sufficient willpower to execute this optimal plan.