Valuation of Rate of Return Guarantees under a Defined Contribution Pension Plan Considering the Choice of Retirement Age

Abstract

This paper studies the valuation of the rate of return guarantee under a DC pension plan considering the choice of retirement age. In this setting, the rate of return guarantee can be referred to as the American option. We carry out a simulation study using the Least Squares Monte Carlo (LSM) approach proposed by Longstaff and Schwartz (2001) to calculate the value of the rate of return guarantee. We also compare the results with the case where the retirement age is fixed. We illustrate the valuation of the rate of return guarantee for the new Labor Pension Plan in Taiwan. The numerical analysis demonstrates that the guarantee value is lower with early retirement but higher with late retirement. The effect of the retirementage on the value of the rate return guarantee is significant.