Incorporating Heterogeneity into Default Rules for Retirement Plan Selection
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Abstract
This paper examines the effect of incorporating individual-level heterogeneity into default rules for retirement plan selection. We use data from a large employer that transitioned from a defined benefit (DB) plan to a defined contribution (DC) plan, offering existing employees a one-time opportunity to make an irrevocable choice between plans. Employees who did not make a choice were defaulted to switch to the DC plan if under age 45 or remain in the DB plan if age 45 or older. Using a regression discontinuity framework, we estimate that the default increased the probability of enrolling in the default plan by 60 percentage points. We develop a framework to solve for the optimal age-based default rule analytically and use our results to empirically evaluate the optimal age-based default rule for the firm in our setting. Our simulations show that for a broad range of levels of risk aversion, allowing the default for the choice between pension plans to vary by age can substantially improve outcomes relative to a universal default policy. Our results suggest that considerable welfare gains are possible in our model by varying defaults by observable characteristics.
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2010 RRC