Working paper

People’s pensions are an important source of retirement income. Although the risk associated with pensions varies widely depending on the pension scheme, all pension plans expose their participants’ pension savings to some market risk.

In this paper we quantify the effects of this pension risk on people’s investment investments; an important way in which they save and accumulate wealth. To do this we exploit a 2007 pension reform in The Netherlands that suddenly exposed people’s pensions to stock market risk. Before the reform, retirement in The Netherlands was typically organised in standard defined benefit schemes—where retirement income was fixed and depended solely on people’s pre-retirement wages and contributions. The reform suddenly linked the financial health of pension funds to the benefits their contributors and retirees receive. This effectively exposed these people to market risk through their pensions.

We show that, after this reform, people who participate in safer pension funds are more likely to invest in stocks, mostly taking their investment from cash savings. These estimates are causal: they cannot be explained by other things that happen to people at the same time their pensions become riskier, nor can they be explained by differences between people who have safer or riskier pensions. We also show the effects of pension risk are stronger for people who are more aware and informed about their pension arrangements, retirees, and people close to retirement. However, pension risk does not affect people’s intentions or decisions to work or their motivations for saving.

Our findings show that pension risk can deeply affect people’s decisions, and that pension reforms that increase exposure to this risk can have important and unintended effects that can affect people’s welfare. This is especially true for pension risk born later in life, when working becomes harder and costly and there are fewer ways to adapt to this risk. The effect of pension risk on people’s behaviour and welfare, and the way this risk gets distributed across socioeconomic strata, should be considered when introducing new retirement schemes and considering alternatives for pension reform.

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Life Course Centre Working Paper No. 2020-06