Working Paper: NBER ID: w12392
Authors: Wolfram J. Horneff; Raimond Maurer; Olivia S. Mitchell; Ivica Dus
Abstract: 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.
Keywords: retirement income; annuitization; asset allocation; risk aversion
JEL Codes: G22; G23; J26; J32; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fixed percentage withdrawal strategy (D14) | financial security (D14) |
| risk aversion increases (D81) | crowd out bonds and equities with annuities (G23) |
| making annuitization compulsory (G52) | substantial utility losses for less risk-averse investors (D11) |
| delay annuitization until later in retirement (J26) | higher utility (L97) |
| market conditions and individual risk tolerance (G11) | optimal annuitization timing (C41) |
| fixed percentage withdrawal strategy (D14) | shift in portfolio composition (G11) |