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The Behavioral Economics of Retirement Savings Behavior

Defined contribution (DC) pension plans transfer much of the decision-making authority about how much to save and how to invest from the employer or government to the employee. DC plans have many attractive features for participants, such as portability and flexibility, but these attractions come with an increased responsibility to choose wisely. Even among economists, it is rare to find someone who has spent much time determining the optimal savings rate, given all the uncertainties about future rates of return, income flows, retirement plans, health, and so forth. Instead, most people attempt to cope by adopting simple heuristics, or rules of thumb. Such heuristics, though often useful and accurate, can lead to systematic biases.

This AARP Public Policy Institute Issue Paper investigates both the heuristics and the biases that emerge in this important domain. The authors examine the decisions employees make about whether to join the savings plan, how much to contribute, and how to invest, and then discuss the possible role of two types of employer interventions—education and plan design.

The paper grew out of the lecture “Libertarian Paternalism, Behavioral Economics, and Public Policy” presented by Professor Thaler in July 2005 as part of PPI’s Twentieth Anniversary Invitational Lecture Series. (33 pages)