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Following the rules: Integrating asset allocation and annuitization in retirement portfolios

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  • Horneff, Wolfram J.
  • Maurer, Raimond H.
  • Mitchell, Olivia S.
  • Dus, Ivica

Abstract

Financial advisers have developed standardized payout strategies to help Baby Boomers manage their money in their golden years. Prominent among these are phased withdrawal plans offered by mutual funds including the "self-annuitization" or default rules encouraged under US tax law, and fixed payout annuities offered by insurers. Using a utility-based framework, and taking account of stochastic capital markets and uncertain lifetimes, we first evaluate these rules on a stand-alone basis for a wide range of risk aversion. Next, we permit the consumer to integrate these standardized payout strategies at retirement and compare the results. We show that integrated strategies can enhance retirees' well-being by 25%-50% for low/moderate levels of risk aversion when compared to full annuitization at retirement. Finally, we examine how welfare changes if the consumer is permitted to switch to a fixed annuity at an optimal point after retirement. This affords the retiree the chance to benefit from the equity premium when younger, and exploit the mortality credit in later life. For moderately risk-averse retirees, the optimal switching age lies between 80 and 85.

Suggested Citation

  • Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Dus, Ivica, 2008. "Following the rules: Integrating asset allocation and annuitization in retirement portfolios," Insurance: Mathematics and Economics, Elsevier, vol. 42(1), pages 396-408, February.
  • Handle: RePEc:eee:insuma:v:42:y:2008:i:1:p:396-408
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    References listed on IDEAS

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    Cited by:

    1. Wolfram J. Horneff & Raimond H. Maurer, 2008. "Deferred Annuities and Strategic Asset Allocation," Working Papers wp178, University of Michigan, Michigan Retirement Research Center.
    2. Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Stamos, Michael Z., 2010. "Variable payout annuities and dynamic portfolio choice in retirement," Journal of Pension Economics and Finance, Cambridge University Press, vol. 9(02), pages 163-183, April.
    3. Jingjing Chai & Wolfram Horneff & Raimond Maurer & Olivia S. Mitchell, 2009. "Extending Life Cycle Models of Optimal Portfolio Choice: Integrating Flexible Work, Endogenous Retirement, and Investment Decisions with Lifetime Payouts," Working Papers wp204, University of Michigan, Michigan Retirement Research Center.
    4. Hong-Chih Huang, 2010. "Optimal Multiperiod Asset Allocation: Matching Assets to Liabilities in a Discrete Model," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(2), pages 451-472.
    5. Andrey Kudryavtsev & Shosh Shahrabani & Yaniv Azoulay, 2017. "Frequency of Adjusting Asset Allocations in the Life-Cycle Pension Model: When Doing More Is Not Necessarily Better," Bulletin of Applied Economics, Risk Market Journals, vol. 4(1), pages 13-33.
    6. Jeffrey R. Brown & Arie Kapteyn & Erzo F.P. Luttmer & Olivia Mitchell, 2012. "Do Consumers Know How to Value Annuities? Complexity as a Barrier to Annuitization," Working Papers WR-924-SSA, RAND Corporation.
    7. Konicz, Agnieszka Karolina & Mulvey, John M., 2015. "Optimal savings management for individuals with defined contribution pension plans," European Journal of Operational Research, Elsevier, vol. 243(1), pages 233-247.
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    9. Sutcliffe, Charles, 2015. "Trading death: The implications of annuity replication for the annuity puzzle, arbitrage, speculation and portfolios," International Review of Financial Analysis, Elsevier, vol. 38(C), pages 163-174.
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    12. Wolfram J. Horneff & Raimond H. Maurer & Olivia S. Mitchel & Michael Z. Stamos, 2008. "Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts," Working Papers wp177, University of Michigan, Michigan Retirement Research Center.
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    14. Horneff, Vanya & Kasch├╝tzke, Barbara & Maurer, Raimond & Rogalla, Ralph, 2014. "Welfare implications of product choice regulation during the payout phase of funded pensions," Journal of Pension Economics and Finance, Cambridge University Press, vol. 13(03), pages 272-296, July.
    15. Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Stamos, Michael Z., 2009. "Asset allocation and location over the life cycle with investment-linked survival-contingent payouts," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1688-1699, September.
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    17. Wolfram J. Horneff & Raimond H. Maurer & Michael Z. Stamos, 2008. "Optimal Gradual Annuitization: Quantifying the Costs of Switching to Annuities," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(4), pages 1019-1038.
    18. Jeffrey R. Brown & Arie Kapteyn & Erzo F.P. Luttmer & Olivia S. Mitchell, 2017. "Cognitive Constraints on Valuing Annuities," Journal of the European Economic Association, European Economic Association, vol. 15(2), pages 429-462.
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