Drawing Down Retirement Savings—do Pensions, Taxes and Government Transfers Matter Much for Optimal Decisions?

Abstract

This paper examines the importance of pensions (employment and social security), taxes and government transfers for alternative retirement savings drawdown strategies (DS), compared to the conventional approach in published literature of using a gross income concept obtainable from retirement savings alone. Using a lifetime utility framework, our longitudinal dynamic micro-simulation model incorporates risk aversion, stochastic markets, stochastic mortality and the interactions among sources of retirement income within the complex Canadian tax and social benefit system, enabling us to rank commonly advocated DS and to ask whether incorporating pensions, taxes and transfers alters those rankings. Our findings show the importance of treating the evaluation of alternative DS as a comprehensive and integrated problem by including all sources of income — including pensions, taxes and government transfers. Using restricted income measures can potentially lead to simplistic, and possibly misleading, conclusions.