Annuitization with Phased Consumption Requirements: Who, When and How Much

Abstract

This paper provide a methodology to find the optimal annuitization strategies that minimize initial wealth required at retirement allowing a given lifetime ruin probability. Previous results are extended, first to the case when annuity prices are not of fair value, then to the case when the required consumptions trajectory is not constant but follows a U shape. Numerical examples show the benefit of annuitization for retirees with different risk preferences in both cases. Given current annuity prices in Australia, there is very little incentive for retirees to annuitize; by incorporating life annuities into a financial strategy, a retiree is only able to reduce the wealth required at retirement by about 4%. There is however huge potential for improvement, as when annuity prices provide fair value, the same retiree can reduce her required saving by about 30%. This is a significant benefit and it is subject of future research for ways to effectively share it between the retiree, the insurer and the government.