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Betting on death and capital markets in retirement: A shortfall risk analysis of life annuities versus phased withdrawal plans

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  • Dus, Ivica
  • Maurer, Raimond H.
  • Mitchell, Olivia S.

Abstract

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. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2004/01.

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Date of creation: 2004
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Handle: RePEc:zbw:cfswop:200401

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Keywords: Insurance; Pensions; Retirement and Retirement Policies; Social Security and Public Pensions;

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Cited by:
  1. Thorburn, Craig & Rocha, Roberto & Morales, Marco, 2006. "An analysis of money's worth ratios in Chile," Policy Research Working Paper Series 3926, The World Bank.
  2. Wolfram Horneff & Raimond Maurer & Olivia Mitchell & Michael Stamos, 2007. "Money in Motion: Dynamic Portfolio Choice in Retirement," Working Papers, University of Michigan, Michigan Retirement Research Center wp152, University of Michigan, Michigan Retirement Research Center.
  3. Wolfram J. Horneff & Raimond Maurer & Olivia S. Mitchell & Ivica Dus, 2006. "Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion," NBER Working Papers 12392, National Bureau of Economic Research, Inc.
  4. Huang, H. & Milevsky, M. A. & Wang, J., 2004. "Ruined moments in your life: how good are the approximations?," Insurance: Mathematics and Economics, Elsevier, vol. 34(3), pages 421-447, June.
  5. Wei Sun & Robert K. Triest & Anthony Webb, 2007. "Optimal retirement asset decumulation strategies: the impact of housing wealth," Public Policy Discussion Paper, Federal Reserve Bank of Boston 07-2, Federal Reserve Bank of Boston.
  6. Gaobo Pang, Mark J. Warshawsk, . "Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses," Research Reports, Watson Wyatt Worldwide 4, Watson Wyatt Worldwide.
  7. MacDonald, Bonnie-Jeanne & Cairns, Andrew J.G., 2011. "Three retirement decision models for defined contribution pension plan members: A simulation study," Insurance: Mathematics and Economics, Elsevier, vol. 48(1), pages 1-18, January.
  8. Estelle James & Guillermo Martinez & Augusto Iglesias, 2005. "The Payout Stage in Chile: Who Annuitizes and Why?," Working Papers, Superintendencia de Pensiones 14, Superintendencia de Pensiones, revised May 2007.
  9. Ferro, Gustavo, 2008. "Un impulso al mercado de rentas vitalicias en España
    [Promoting the annuities market in Spain]
    ," MPRA Paper 20211, University Library of Munich, Germany, revised Jul 2008.
  10. Ferro, Gustavo, 2008. "On annuities: an overview of the issues," MPRA Paper 20209, University Library of Munich, Germany, revised Oct 2009.

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