A new strategy to guarantee retirement income using TIPS and longevity insurance

Abstract Retirees investing their savings in stocks and bonds face the risk of financial ruin even whenwithdrawing as little as 4% annually. This paper proposes a new investment strategy using TreasuryInflation Protected Securities and longevity insurance that would guarantee real annual withdrawalrates in excess of 5% without any risk of financial ruin. The strategy can be implemented at minimalcost by retirees and their financial advisers. Institutional providers can use this strategy to offerproducts that would provide inflation adjusted lifetime incomes and allow retirees to retain controlover most of their savings in retirement. © 2009 Academy of Financial Services. All rights reserved. JEL classification: D14 (personal finance), G22 (Insurance) Keywords: Retirement planning; Withdrawal rates; TIPS; Longevity; Financial ruin 1. Introduction The search for the optimal withdrawal rate, the rate that minimizes the prospect of eitherhaving too small a retirement income or running out of money in retirement, is an ongoingquest for retirees and their financial advisers. The current consensus in the literature suggeststhat retirees can expect to withdraw at a real rate of about 4% of their initial savings byinvesting in portfolios of stocks and bonds, though even at this rate they face a small risk offinancial ruin or running out of money in retirement. The risk of financial ruin increasessignificantly with higher withdrawal rates.