Individual Risk in an Investment-Based Social Security System

By Martin Feldstein, E. Ranguelova. 2001

148 citations recorded by the source corpus.

This paper examines the risk aspects of an investment-based defined contribution Social Security plan. We focus on the risk after the plan is fully phased in. Individuals deposit a fraction of wages to a Personal Retirement Account (PRA), invest these funds in a 60:40 equity-debt mix, and in a similarly invested annuity at age 67. The value of the assets follows a random walk with mean and variance of a 60:40 equity-debt portfolio over the period 1946-95, a mean log return of 5.5 percent (net of administrative costs of 0.4 percent) and a standard deviation of 12.5 percent. We study he stochastic distributions of this process by doing 10,000 simulations of the 80-year experience of the cohort that reached age 21 in 1998. The resulting annuities are compared to the future defined benefits specified in current law (the benchmark' benefits). With no uncertainty, a 5.5 percent log return would permit the benchmark benefits to be purchased with PRA deposits of 3.1 percent of payroll, only one-sixth of the pay-as-you-go tax needed for the benchmark benefits. Saving a higher share of wages provides a cushion' that protects the individual from the risk of an unacceptably low level of benefits. For example, PRA deposits of 6 percent of wages reduces the probability that the benefits are less than the benchmark to 0.17 and the probability that they are less than 61 percent of the benchmark to 0.05. PRA deposits of 9 percent of wages (half of the tax rate required in a pay-as-you-go system) would substantially reduce these risks. This pure investment-based plan is an extreme case. The investment risk can be reduced further by using a mixed system that combines pay-as-you-go and investment-based components or that makes intergenerational transfers conditional on the performance of stock and bond prices.

Subfields: Accounting, Demography, Management Science and Operations Research

View Paper: https://www.semanticscholar.org/paper/047ed30731427902530595dff21db7df602e41b0

How researchers see this paper

The researchers whose trusted networks rank it highest, strongest advocate first. Every researcher gets a different order.

In Accounting

In Demography

In Management Science and Operations Research

Citations in the corpus

Optimal insurance in a continuous-time model (2006, background): “In the context of estimating the present value of a variable annuity for Social Security, Feldstein and Ranguelova (2001) argue that the value of CRRA is less than 3 and probably even less than 2.”
Annuitization and asset allocation (2007, background): “(21) Because the above policy is in general suboptimal, (21) holds as an inequality; that is, for all (w,A, t),”
Pensionmetrics 2: stochastic pension plan design during the distribution phase (2003, background): “19 Some of the published values are controversial, and Feldstein and Ranguelova (2001) have recently suggested that the literature tends to over-estimate RRAs.”
Optimal Portfolio Choice over the Life-Cycle with Flexible Work, Endogenous Retirement, and Lifetime Payouts (2011, background): “29 See also Battistin, Brugiavini, and Weber (2009).”