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Pension behavior and policy
journal contributionposted on 15.07.2021, 00:33 by Philip Newall, Mike W Peacey
Individuals benefit from smoothing consumption over time, a fact well illustrated in the domain of pension spending. But many potential benefits from consumption smoothing are lost in practice due to an overconsumption in the present and near-future compared to the far-future, which is known as “present bias”. Present bias's impact on pensioner welfare could potentially be exacerbated by international trends toward greater pension freedoms. However, actual pension spending decisions can involve sudden transitions into bankruptcy, which are hard to reconcile even with behavioral hyperbolical discounting models that are traditionally used to explain present bias. We consider an intertemporal consumption problem from a time-consistent but bounded rationality perspective. In this limited foresight framework, an individual exponentially discounts utilities (at constant rate, r) for a finite amount of time (until S) but ignores utilities that occur beyond that (up to T). The consumption paths implied by this simple model involve sudden transitions into bankruptcy at time S, resembling observed patterns from an international dataset on pension spending. Furthermore, this perspective suggests that individuals could be helped to appropriately smooth consumption over time via policy interventions directed at extending their level of foresight.