Optimal Annuity Purchases for Australian Retirees

Abstract

We develop and simulate a stochastic lifecycle model to investigate optimal annuity purchases at retirement. Retirees can invest in risky assets, purchase fairly priced immediate or deferred lifetime annuities, and are eligible for a targeted safety net pension. We match baseline parameters to current Australian settings and market outcomes. Except where individuals need to insure a consumption floor, both immediate and deferred annuity purchases are largely crowded out by the means tested public pension. Welfare losses caused by zero annuitisation are small compared with the losses caused by completely annuitising all savings, particularly if wealth at retirement is low. Decumulation policy should ensure individuals are well-informed of the insurance value of annuities and accommodate diverse choices.

Keywords: life cycle, household finance, longevity risk

JEL Classification: D140, D910, G230