Annuitization with phased consumption requirements: who, when and how much

Purpose: Find the strategy which minimizes initial wealth required allowing a given lifetime ruin probability. Originality: The required consumption is assumed to be different for different ages and forms a U shape, reflecting the notion of different consumption requirement of different phases in retirement. Key literature / theoretical perspective: Milevky, Moore and Young (2005) 'Asset Allocation and Annuity-Purchase Strategies to Minimize the Probability of Financial Ruin'. Design/methodology/approach: I used a historical scenario approach to model stock return, instead of assuming a normal distribution. Findings: 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%. Research limitations/implications: This paper also do not consider bequest motive and only assumes known future consumption, and does not take into account publicly provided age pensions. Practical and Social implications: There is a significant benefit of annuitization to retirees and government, however future research is required for an effective ways to make effective use of it.