Chapter

Chapter Chapter <b>The Future of Pension Plan Design</b>

David McCarthy

in Reinventing the Retirement Paradigm

Published in print August 2005 | ISBN: 9780199284603
Published online February 2006 | e-ISBN: 9780191603013 | DOI: http://dx.doi.org/10.1093/0199284601.003.0006
Chapter  Chapter   The Future of Pension Plan Design

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This chapter brings together the literature on pension compensation and optimal portfolio choice to seek solutions to the ‘pension design’ problem. It identifies the factors that must be taken into account when designing pension schemes. It then discusses life cycle models of employee preferences, presents a specific model of this type, and presents some results. It is shown that defined benefit (DB) pension arrangements magnify the risk exposure of an individual to salary risk, and both defined contribution (DC) and DB pension arrangement defer the pay of younger workers to later in their lives. In contrast, DB pensions may be a cost-effective method of compensation for older, less well-educated employees. Promising workers a stake in an underfunded pension plan is an expensive way to pay employees, particularly if the underfunding has no positive impact on effort. Giving workers 401(k) plans holding restricted company stock is also an expensive way to remunerate employees, because they are already heavily exposed to company risk.

Keywords: pension plans; retirement plans; defined benefit plans; defined contribution plans

Chapter.  8024 words. 

Subjects: Financial Markets

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