Betting on Death and Capital Markets in Retirement: A Shortfall Risk Analysis of Life Annuities versus Phased Withdrawal Plans

How might retirees consider deploying the retirement assets accumulated in a defined contribution pension plan? One possibility would be to purchase an immediate annuity. Another approach, called the “phased withdrawal” strategy in the literature, would have the retiree invest his funds and then withdraw some portion of the account annually. Using this second tactic, the withdrawal rate might be determined according to a fixed benefit level payable until the retiree dies or the funds run out, or it could be set using a variable formula, where the retiree withdraws funds according to a rule linked to life expectancy. Using a range of data consistent with the German experience, we evaluate several alternative designs for phased withdrawal strategies, allowing for endogenous asset allocation patterns, and also allowing the worker to make decisions both about when to retire and when to switch to an annuity. We show that one particular phased withdrawal rule is appealing since it offers relatively low expected shortfall risk, good expected payouts for the retiree during his life, and some bequest potential for the heirs. We also find that unisex mortality tables if used for annuity pricing can make women’s expected shortfalls higher, expected benefits higher, and bequests lower under a phased withdrawal program. Finally, we show that delayed annuitization can be appealing since it provides higher expected benefits with lower expected shortfalls, at the cost of somewhat lower anticipated bequests.

Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion

Retirees must draw down their accumulated assets in an orderly fashion so as not to exhaust their funds too soon. We derive the optimal retirement portfolio from a menu that includes payout annuities as well as an investment allocation and a withdrawal strategy, assuming risk aversion, stochastic capital markets, and uncertain lifetimes. The resulting portfolio allocation, when fixed as of retirement, is then compared to phased withdrawal strategies such a "self-annuitization" plan or the 401(k) 'default' pattern encouraged under US tax law. Surprisingly, the fixed percentage approach proves appealing for retirees across a wide range of risk preferences, supporting financial planning advisors who often recommend this rule. We then permit the retiree to switch to an annuity later, which gives her the chance to invest in the capital market and "bet on death." As risk aversion rises, annuities first crowd out bonds in retiree portfolios; at higher risk aversion still, annuities replace equities in the portfolio. Making annuitization compulsory can also lead to substantial utility losses for less risk-averse investors.

Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion

Retirees must draw down their accumulated assets in an orderly fashion so as not to exhaust their funds too soon. We derive the optimal retirement portfolio from a menu that includes payout annuities as well as an investment allocation and a withdrawal strategy, assuming risk aversion, stochastic capital markets, and uncertain lifetimes. The resulting portfolio allocation, when fixed as of retirement, is then compared to phased withdrawal strategies such a %u201Cself-annuitization%u201D plan or the 401(k) %u201Cdefault%u201D pattern encouraged under US tax law. Surprisingly, the fixed percentage approach proves appealing for retirees across a wide range of risk preferences, supporting financial planning advisors who often recommend this rule. We then permit the retiree to switch to an annuity later, which gives her the chance to invest in the capital market and %u201Cbet on death.%u201D As risk aversion rises, annuities first crowd out bonds in retiree portfolios; at higher risk aversion still, annuities replace equities in the portfolio. Making annuitization compulsory can also lead to substantial utility losses for less risk-averse investors.

Cost Average-Effekt: Fakt oder Mythos?

For practitioners, the Cost-Average phenomenon is part of the basic knowledge concerning investment theory. The core effect lies within the possibility to achieve in average a lower acquisition cost compared to the average price of the stock or investment fund. With the regu-lar investment of equal amounts, more shares can be bought, when prices are low and less share are bought, when prices are high. Above this, many practitioners attribute increased significance to the Cost-Average phenomenon, by deducing that savings plans, compared to a lump sum investments, in general reduce the timing risk. In this paper, we theoretically check this rather intuitive conclusion. The main focus is on a specific analysis of risk- and return consequences of investment plans compared to lump sum investments. We find that regarding both the terminal value and the shortfall-probability regarding a nominal capital maintenance investment plans are inferior to lump sum investments. In contrast, with respect to the average amount of loss in case of a loss, the investment plan turns out to be the better strategy.

Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion

Retirees must draw down their accumulated assets in an orderly fashion so as not to exhaust their funds too soon. We derive the optimal retirement portfolio from a menu that includes payout annuities as well as an investment allocation and a withdrawal strategy, assuming risk aversion, stochastic capital markets, and uncertain lifetimes. The resulting portfolio allocation, when fixed as of retirement, is then compared to phased withdrawal strategies such a “self-annuitization” plan or the 401(k) “default” pattern encouraged under US tax law. Surprisingly, the fixed percentage approach proves appealing for retirees across a wide range of risk preferences, supporting financial planning advisors who often recommend this rule. We then permit the retiree to switch to an annuity later, which gives her the chance to invest in the capital market and “bet on death.” As risk aversion rises, annuities first crowd out bonds in retiree portfolios; at higher risk aversion still, annuities replace equities in the portfolio. Making annuitization compulsory can also lead to substantial utility losses for less risk-averse investors

Zur Eigenmittelunterlegung von Leistungszusagen in der Auszahlphase bei investmentfondsbasierten Altersvorsorgeverträgen: Ein Gestaltungsvorschlag

Own Fund Requirements Relating to Defined Benefits Payable in the Withdrawal Phase under Investment Fund-Based Contracts to Make Provision for Old Age: A Proposal on How to Shape this RequirementThe present study focuses on the defined financial benefits capital investors have undertaken to pay to their contracting parties during the withdrawal phase under contracts making provision for old age (also referred to as Riester contracts in Germany). The Alterszertifizierungsgesetz requires product providers to make sure that benefits, equal or even increasing in amount over time, are paid to the holders of such Riester contracts during the entire withdrawal phase. In cases of doubt, investors would be liable in respect of their total assets and therefore be required to hold own funds appropriate in amount. At present, there are not any explicit supervisory-law rules covering own fund requirements during the withdrawal phase under investment-based contracts making provision for old age. The present study is aimed at closing this gap. To this end, it begins by enlisting the special financial and economic characteristics of defined benefits during the withdrawal phase; this is followed by a discussion of a conceptual proposal as well as of specific methodological proposals pertaining to a supervisory law-based own fund system; finally it demonstrates the way such a system would work within the framework of a simulation study