Discounting and Consumption Over an Uncertain Horizon: Draw-Down Plans for Family Trusts

Abstract

Individuals, endowments and trusts face uncertain lifetimes. When the planning horizon of an entity is stochastic and Pareto distributed, hyperbolic discounting and time-varying consumption rates are optimal. We derive expressions for the optimal rate of consumption (draw-down) from wealth for family trusts facing positive probabilities of extinction at each generation. Using birth statistics for the UK, we compute family extinction probabilities and show that they are well-approximated by a Pareto distribution, hence family trusts will discount hyperbolically. Numerically optimised consumption paths for family trusts with CRRA preferences are decreasing but always higher than for infinitely-lived trusts.family extinction; hyperbolic discounting; inter-temporal choice