Cross-country comparisons are not affected by this interest rate assumption. For simplicity, we set the gross real interest rate, R, to one (i.e., we set the net real interest rate to zero). We assume permanent income is Y = US$60,000, which is approximately the median household income in each of the six countries. Because we are studying a situation in which the household may have a liquidity need at a pre-eligible age, we calculate how the MRT varies as we change y. Likewise, τ( eligible, Y) is the marginal tax rate on a $1 withdrawal from the DC plan when (i) the household is old enough to be eligible to make withdrawals and (ii) household earnings in the withdrawal year equal permanent income, Y. In this equation, τ( pre, y) is the marginal tax rate (accounting for penalties and phase-outs of means-tested benefits) on a $1 withdrawal from the DC plan when (i) the household is young enough to be at a pre-eligible withdrawal age and (ii) the household's employment income, y, in the withdrawal year is less than or equal to the household's permanent income, Y. For example, should liquidations be normalized by DC balances, retirement assets, total assets, or GDP? Also, from an economic perspective, the most natural object to study is the marginal price because it summarizes the incentives that consumers face.Īccordingly, we compute the marginal rate of transformation ( MRT) between withdrawal-funded consumption at ages when the household is “ pre-eligible” for withdrawals and withdrawal-funded consumption at ages when the household is “eligible” to make withdrawals (in all countries that we study, eligibility begins no earlier than 55 and no later than 63): 9, 10, 11 Even if such statistics were readily available, it is unclear how they should be compared across countries. We use the marginal price because statistics on actual liquidations are difficult to obtain. There are many ways to measure liquidity, including the actual quantity of liquidations or the marginal price of liquidations.
8 Third, in most circumstances, DC assets are at least as liquid as DB assets, so DC assets are the relevant margin for a household considering liquidating retirement wealth to augment pre-retirement consumption. Second, DC plans already have more than half of retirement wealth in three of the countries that we study: Australia, Singapore, and the United States. First, DC plans are gaining assets relative to DB plans in almost all countries around the world, including the six that we study. We analyze employer-based DC plans instead of defined benefit (DB) plans for three reasons.
6 We also analyze Germany, the largest developed economy with a substantial pool of DC savings that does not have English as an official language. We focus on the five highest-GDP developed countries that have English as an official language: the United States, the United Kingdom, Canada, Australia, and Singapore.
4 This amount of leakage may or may not be socially optimal, an issue that is beyond the scope of the current paper. Liquidity generates significant pre-retirement “leakage” in the United States: for every $1 contributed to the DC accounts of savers under age 55 (not counting rollovers), $0.40 simultaneously flows out of the DC system (not counting loans or rollovers). Pre-eligibility IRA withdrawals may be made for any reason by paying a 10 percent tax penalty, and certain classes of pre-eligibility IRA withdrawals are exempt from this penalty. In the United States, employer-sponsored DC account balances can be moved to an Individual Retirement Account (i.e., a “rollover” IRA) once the individual no longer works for the employer, which provides considerable scope for liquidation before the withdrawal-eligibility age of 59½.
We find that all of them, with the sole exception of the United States, have made their DC systems overwhelmingly illiquid before age 55. This paper compares the liquidity that six developed economies have built into their employer-based defined contribution (DC) retirement savings systems. 1 On the other hand, pre-retirement liquidity is undesirable when it leads to under-saving arising from, for example, planning mistakes or self-control problems. What is the socially optimal level of liquidity in a retirement savings system? Liquid retirement savings are desirable because liquidity enables agents to flexibly respond to pre-retirement events that raise the marginal utility of consumption, like medical emergencies or income shocks.
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