Recognizing households’ needs for flexibility, while discouraging overconsumption, how much liquidity should be built into a socially optimal savings system?
The government chooses mandatory contributions to respective spending and savings accounts, each with a different pre-retirement withdrawal penalty. Penalties collected by the government are redistributed through the tax system. This paper calculates the socially optimal level of illiquidity in an economy populated by households with taste shocks and present bias.
The authors evaluate the optimality of an N-account retirement savings system with a combination of liquid, partially illiquid, and/or fully illiquid accounts. The illiquidity is obtained with linear penalties for early withdrawals. Within this framework, they focus on two special cases: systems with two accounts and systems with three accounts.