Acturial Adjustment Aspects of Public Pension Schemes

It has been shown in economic research that public pay-as-you-go defined-benefit pension plans penalize those who continue to work beyond a certain age by reducing the present discounted value of future retirement benefits. In discussions on the effectiveness of policies aimed at eliminating this age-dependency in worker retirement decisions, it is often assumed either that the benefits in all future periods have the same weight in the present discounted value or that the discount rate is close to unity due to low real interest rates used in this case. In this paper we show, using the example of the U.S. pension scheme, that discounting plays a crucial role, since the formula for the present discounted value of future retirement benefits is sensitive to the discount rate used. Using discount rates derived from real interest rates in 1997, we find that the annual delayed retirement credit by which retirement benefits should be increased to compensate for lost benefits is at least 25% greater than it is in the case when discounting is neglected. Moreover when accouting for risk aversion towards lifetime uncertainty, the optimal delayed retirement credit is increased by 15- 25%. Our results indicate that the U.S. pension scheme is not age neutral between ages 62 and 65. This may explain the peak in labor force withdrawal observed at age 62.