Ch. 7: LIFE-CYCLE ASPECTS OF LABOR SUPPLY. • Choice of retirement age Choice of retirement age • Steepness of I-curve – reflects willingness to postpone retirement for additional income. • Steepness of budget constraint determined by – earnings profile – Social Security formula – pension plan features • Pure Wealth effect would result from a parallel shift of budget constraint (e.g. win lottery, inherit money) • Wealth and substitution effect would result if slope of budget constraint is altered. Choice of retirement age • If the financial rewards to postponing retirement beyond age 62 are increased, the person with is faced with a wealth and substitution effect. • Wealth effect: Holding retirement age constant, the person has greater wealth and will retire sooner. • Substitution Effect: Holding wealth constant, the reward to postponing retirement has increased .. substitute money for years in retirement. • Net effect: Ambiguous. Choice of retirement age • Effect of increasing rewards to postponed retirement subst efffect > Wealth effect Wealth effect > subst efffect R* Choice of retirement age How do each of the following affect retirement age? • steepness of earnings profile? • Social Security formulae • Calculating AIME & PIA • reductions for early retirement • credits for postponed retirement. Choice of retirement age Private pensions •Defined benefit plan • life annuity promised at retirement. • annuity payment generally tied to years of service, final salary, and a "generosity factor". • PV of defined benefit plan may eventually fall with retirement age (fewer years to collect annuity versus increase in size of annuity). • “Actuarially fair” adjustment for postponing retirement by one year keeps PV of pension independent of retirement age. • If life expectancy is 80, what is actuarially fair adjustment for a worker who collect an annuity of $50,000 annually at age 65, assuming interest rate=0? If interest rate>0? Choice of retirement age Private pensions •Defined Contribution Plan. •a savings account that the worker may receive as a lump sum at retirement. • PV of defined contribution plan grows with retirement age because contributions are added over time. • Over time, there has been a switch from defined benefit to defined contribution plans. • What's the effect of switching from DB to DC plans on retirement incentives?