[Paper Review] Costly Attention and Retirement

Jamie Hentall MacCuish|ArXiv.org|Apr 13, 2019

Retirement, Disability, and Employment4 citations

TL;DR

This paper integrates costly attention—modeled via rational inattention—into a dynamic life-cycle retirement model to explain why labor market exits concentrate at official retirement ages despite weak incentives. It shows that endogenous, heterogeneous mistaken beliefs about the UK female State Pension Age (SPA) significantly improve model predictions of labor supply responses, while also explaining low take-up of actuarially advantageous deferral options due to attention costs.

ABSTRACT

In UK data, I document the prevalence of misbeliefs regarding the State Pension eligibility age (SPA) and their predictivity for retirement. Exploiting policy variation, I estimate a lifecycle model of retirement in which, motivated by patterns in belief data, rationally inattentive households learning about uncertain pension policy endogenously generates misbeliefs. Misbeliefs explain 51% of the excessive (given financial incentives) drop in employment at SPA when constrained to replicate the belief data patterns and completely explain it when not. To achieve this, I develop a solution method for dynamic rational inattention models with persistent beliefs. Costly attention makes the SPA up to 15% less effective at increasing old-age employment. Hence, information letters improve welfare and increase employment.

Motivation & Objective

• To explain the puzzle of excess labor supply sensitivity at official retirement ages despite weak financial incentives.
• To investigate how informational frictions—specifically costly attention to uncertain pension policy—generate endogenous, heterogeneous mistaken beliefs about the State Pension Age (SPA).
• To develop and solve a dynamic rational inattention model with endogenous heterogeneous beliefs, a novel methodological contribution.
• To explain the low take-up of actuarially advantageous pension deferral options using attention costs as a behavioral channel.
• To estimate the cost of attention using survey data on SPA misperceptions and labor supply responses.

Proposed method

• Formulates a dynamic life-cycle model of retirement with rational inattention to uncertain pension policy, using Sims (2003) rational inattention framework.
• Incorporates endogenous heterogeneous beliefs by allowing individuals to optimally allocate attention to learning about their SPA, leading to systematic misperceptions.
• Solves the model using a novel solution methodology that combines recent theoretical advances (Steiner et al., 2017; Caplin and Dean, 2015) to handle the large state space from heterogeneous beliefs.
• Employs simulated method of moments (SMM) to estimate model parameters using data from the English Longitudinal Study of Ageing (ELSA).
• Extends the model to include a stochastic deferral rate and a benefit claiming decision, with attention costs modeled as a fixed cost in consumption units.
• Uses belief data (self-reported SPA) to calibrate the cost of attention, estimating it at £1–100 for full information.

Experimental results

Research questions

• RQ1 Why do labor market exits concentrate at official retirement ages despite weak financial incentives?
• RQ2 How do costly attention and endogenous mistaken beliefs about the State Pension Age (SPA) affect labor supply responses?
• RQ3 What is the role of attention costs in explaining the low take-up of actuarially advantageous pension deferral options?
• RQ4 How do misperceptions about the SPA evolve with age, and how do they correlate with labor supply behavior?
• RQ5 Can a rational inattention model with endogenous heterogeneous beliefs generate realistic patterns of belief formation and labor supply responses?

Key findings

• Mistaken beliefs about the UK female State Pension Age (SPA) are widespread: most women are incorrect about their SPA, and these errors are predictive of labor supply behavior.
• SPA misperceptions decrease with age, suggesting learning occurs over time, consistent with the model’s prediction of endogenous belief updating.
• Introducing costly attention into the model increases the predicted labor supply response to the SPA from 0.0301 to 0.109 in the full population, significantly improving fit with observed data.
• The model with costly attention predicts a negative correlation between SPA misperception and labor supply response: those most misinformed show the smallest response, as the SPA is irrelevant to them.
• In the extension with deferral options, a cost of attention of approximately £10 raises the share claiming early from 2.4% to 19.7%, still below the observed 99% but a substantial improvement.
• The model with attention costs better explains the low take-up of deferral: individuals avoid the cost of learning, even when deferral is actuarially advantageous, due to the attention burden.