Assessing the Impact of Mandatory Financial Guarantees in Individual Retirement Accounts on Saving, Work, and Retiree Wellbeing: The Case of German Riester Plans

Project Start:01/2017
Researchers:Vanya Horneff, Daniel Liebler, Raimond Maurer, Olivia S. Mitchell
Category: Household Finance
Funded by:LOEWE

European workers increasingly must accumulate pension assets, and in their golden years, spend retirement wealth in an orderly fashion. They do so against the backdrop of rapidly-aging populations, the demise of defined benefit plans, a persistent low-return environment, and stressed national pay-as-you-go pensions. In response, nations encourage workers to invest in tax-qualified Individual Retirement Accounts (IRAs), with the German Riester plan being a prominent example. These are voluntary tax-subsidized IRA’s offered to workers by financial intermediaries. A unique feature of these plans is that product providers must promise participants a money-back guarantee during the accumulation phase, and in retirement, the assets must be paid as guaranteed lifetime income. Such guarantees protect against shortfall investment risk and longevity risk to enhance financially-illiterate workers’ retirement security (Lusardi/Mitchell 2014; Lusardi et al. 2016). Yet there are economic costs of such guarantees, which must be financed, and in times such as the present where low returns appear persistent, these costs can be substantial. The objective of this project is to evaluate the economic consequences of alternative Riester guarantee structures for German workers’ saving, work, and welfare. Additionally, guarantee structures have important implications for plan sponsors and regulators designing solvency systems. We ask the following questions:

(i) Are existing guarantees welfare-enhancing for German workers, given their costs?

(ii) What alternative designs might better protect retirees from investment and longevity risk?

We build on lifecycle consumption/portfolio choice research (Blake et al. 2014; Cocco/Gomes 2012; Horneff et al. 2015, 2016). We also extend Lachance/Mitchell (2003) on individual account guarantees. We develop a model for German workers requiring the estimation of risky labor income profiles (by education/sex/family status), realistic tax rules for labor/retirement/investment income, and Social Security rules. The model also accounts for asymmetric mortality, fees, and key exogenous shocks (medical/housing costs, capital markets). We will price guarantees using option pricing and actuarial techniques. Our goal is to evaluate the economic impact of guarantees in a lifecycle model of asset location, regarding how much to hold in tax-qualified and non-tax-qualified accounts, and asset allocation, regarding how to invest in stocks and bonds.

Related Published Papers

Author/sTitleYearProgram AreaKeywords
Vanya Horneff, Raimond Maurer, Olivia S. MitchellHow will Persistent Low Expected Returns Shape Household Economic Behavior?
Journal of Pension Economics & Finance
2019 Household Finance

Related Working Papers

No.Author/sTitleYearProgram AreaKeywords
263Vanya Horneff, Daniel Liebler, Raimond Maurer, Olivia S. MitchellImplications of Money-Back Guarantees for Individual Retirement Accounts: Protection Then and Now2019 Household Finance individual retirement account, investment guarantee, longevity risk, retirement income, life cycle model