(UM04-12) - Self-Annuitization in Personal Accounts: Perspectives from the German Experience
Olivia S. Mitchell and Raimond H. Maurer
Retirees often face the question of how to draw down assets that they have accumulated over their worklives. Many recommend that people should purchase a life annuity to protect them against longevity risk, but here we explore an alternative strategy called a “self-annuitization” or phased withdrawal approach. Here the retiree allocates his funds across various asset categories (e.g. equity, bonds, cash) and periodically withdraws a portion of the invested funds for consumption purposes. The advantage of such a phased withdrawal strategy, as compared to a life annuity, is that it offers greater liquidity, the possibility of greater consumption while alive as well as the possibility of bequeathing some of the assets in the event of early death. Yet relying on income from assets without any insurance provides no pooling of longevity risk. Our paper explores several alternative withdrawal rules that rely not on some fixed amount per period, but rather on consuming a specified fraction of the remaining fund wealth each period. This alternative approach avoids the risk of outliving one’s total assets, as long as the benefit-to-wealth ratio is lower than one. Nevertheless, due to stochastic investment returns, the value of the pension accounts assets change over time implying that the periodically withdrawn amount must vary in tandem – and it could be substantially lower or higher than the benefit payable under a life annuity. To evaluate different decumulation options on a quantitative basis, we adopt a risk-value (or risk-return) model which uses an explicit measure of risk, an explicit measure of value, and a function reflecting the trade-offs between value and risk. Most relevant to policymakers is our finding that mandating annuitization after a phased withdrawal period can be quite appealing in terms of risk. This is of particular interest since this approach has recently been implemented in both the UK and Germany; some annuitization has also been recommended by the US Commission to Strengthen Social Security. We also find that requiring unisex tables for annuity pricing exposes women to potentially greater risk. Finally, our results speak to the asset mix retirees will optimally want to hold: later annuitization (say, at age 85) would imply a larger fraction of the financial assets would be held in bonds.