New Study Urges Rethink of Rigid Pension Contributions

Oct. 21, 2025

For decades, workers have been forced into retirement systems that treat everyone the same: a flat contribution rate deducted from every paycheck, no matter whether you’re a 25-year-old just scraping by or a 55-year-old with a hefty savings cushion. A new study illustrates how this one-size-fits-all approach is at odds with basic principles of consumption-savings theory.

For most workers, saving for retirement is automatic: a fixed share of wages diverted into pension accounts, regardless of age, income, or circumstances. A new study by SHoF researcher Roine Vestman (Stockholm University), Kathrin Schlafmann (Copenhagen Business School), and Ofer Setty (Tel Aviv University) shows that this rigid model is at odds with how people actually save in their voluntary savings accounts (i.e., outside the pension system) and with basic economic theory.

“Constant mandatory contribution rates are at odds with basic principles of consumption-savings theory,” the authors say.

The paper, based on Swedish registry data and a detailed life-cycle model, proposes a system where contribution rates rise with age and adjust depending on how much an individual has already saved relative to their income. This is closer in line with economic theory.

Behavior Already Reflects Theory

The authors show that households outside the pension system act in line with economic theory. Younger workers with steep income growth ahead save less, while older workers approaching retirement put aside more.

“While the average savings rate of individuals aged 25–35 is 1.3%, the corresponding number for individuals aged 56–64 is 3.8%,” the study finds.

Households also react to shocks. A windfall on investments typically prompts a cut in contributions.

“Individuals reduce their contribution rate by about 10 percentage points on average after an increase in their asset balance equivalent to one year’s disposable income,” the paper notes.

Income losses trigger similar adjustments, with a 10% drop in earnings reducing savings by 0.26 percentage points.

A Rule-Based Alternative

Drawing on these patterns, the researchers propose a simple rule based on their model: raise contributions gradually over a worker’s career and adjust if the accumulated savings so far fall short relative to current labor income:

“Every year, the contribution rate should unconditionally increase by 0.3 percentage points. Furthermore, investors who fall short by 1% from the target balance-to-income ratio for their age should increase their contribution rate by 0.15 percentage points,” the authors write.

The authors arrive at this proposal by searching for the best possible formula for the contribution rate, while holding fixed that the average replacement rate (out of labor income late in the life cycle) must be 29%.

The proposed rule implies a welfare gain, measured in terms of how much life-time consumption would need to increase to achieve the same benefits to workers. The model indicates that welfare gain of the proposal corresponds to an increase in consumption by 1.8% every year over the course of life.

This is seen as the right-most pink circle in the above figure, which plots welfare gains of different contribution rate rules conditional on achieving a specific average replacement rate (from 0 to 29%).

“A welfare gain of 1.8% is a substantial number – it corresponds to gains seen from a significant tax reform or to the gains achieved if business cycle fluctuations could be entirely eliminated”, the authors say.  

The authors’ proposal would make the system fairer and more flexible. It would deliver more liquidity early in life and cushion income shocks, lifting consumption for 30-year-olds by nearly 4%. At the same time, retirement inequality would shrink—measured by the spread in replacement rates (pensions as a share of pre-retirement income)—which falls by more than 40% compared with today’s flat-rate system, as shown in the chart below:

 

Robust Even for the Short-Sighted

The model holds even if workers have short planning horizons or limited financial literacy.

“Our proposed policy is optimal even under this assumption,” the authors say, adding that the design yields a similar welfare for workers with a reasonable degree of short-sighted temptation.

Policy Implications

Defined-contribution systems are becoming more important as governments seek to limit the fiscal risks of state pensions. But debates continue over whether workers should be allowed to tap funds early, as during the COVID-19 pandemic. The study suggests flexibility could come instead through contribution rules, without undermining retirement security.

“Designing contribution rates according to consumption-savings theory can improve welfare and substantially reduce inequality in replacement rates while maintaining the same average level of replacement rates,” the authors conclude.