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Menu Choices in Defined Contribution Pension Plans

Aug 2014
Policy Brief
By  Clemens Sialm
Over the last three decades there have been significant changes in the structure of retirement savings in the United States and across the world. Defined Contribution (DC) pension plans, such as 401(k) and 403(b) plans, have become a more important source of retirement funding for many households while the relative importance of government-provided social security has declined and while firms have switched from Defined Benefit (DB) to DC plans. Thus, more savings and investment decisions need to be taken by households, who might not have the time and knowledge to make these important investment decisions. In addition, there are potential conflicts of interest between DC pension plan service providers and retirement savers. The investment choices that maximize the profitability of the service providers do not necessarily correspond to the optimal choices for retirement savers. It is therefore crucial to scrutinize the impact of the DC plan design on savings and investment decisions. I discuss in this policy brief some key findings from two recent research projects that analyze the mutual fund investment options offered in DC pension plans. The structure of the retirement savings system affects the investment strategies, money flows, and performance of retirement savers. An optimal DC plan design needs to take into account behavioral biases and bounded rationality by retirement savers as well as conflicts of interests by service providers.