Addressing the Challenge of Annuity Income Uncertainty: A Dynamic Annuitization Strategy

Abstract

In the aftermath of the financial crisis of 2008, there is increased concern about the potentially catastrophic pension default risk, which results in significant decreases in pension benefits. In order to address the challenge of annuity income uncertainty, I propose a dynamic annuitization strategy through which two potential solutions are presented. On the one hand, restructuring their portfolios by consuming less and saving more turns out to be effective to accumulate more wealth for preparedness after benefits cuts. On the other hand, retirees should review their life annuities and can escalate annuities whenever their wealth-to-annuity ratio exceeds some threshold amount, at no additional cost to the current pension system. The decision to increase annuities in the face of annuity income uncertainty is analogous to deciding when to buy the asset in the presence of transaction costs.

Keywords: Dynamic Annuitization, Consumption, Saving, Investment, Annuity Income Uncertainty

JEL Classification: C61, E21, G11