Optimal Consumption, Investment and Housing with Means-Tested Public Pension in Retirement

28 Pages Posted: 28 Jun 2016 Last revised: 6 May 2018

See all articles by Johan Andreasson

Johan Andreasson

University of Technology Sydney (UTS); CSIRO Australia

Pavel V. Shevchenko

Macquarie University; Macquarie University, Macquarie Business School

Alex Novikov

University of Technology Sydney (UTS)

Date Written: July 11, 2016

Abstract

In this paper, we develop an expected utility model for the retirement behavior in the decumulation phase of Australian retirees with sequential family status subject to consumption, housing, investment, bequest and government provided means-tested Age Pension. We account for mortality risk and risky investment assets, and introduce a health proxy to capture the decreasing level of consumption for older retirees. Then we find optimal housing at retirement, and optimal consumption and optimal risky asset allocation depending on age and wealth. The model is solved numerically as a stochastic control problem, and is calibrated using the maximum likelihood method on empirical data of consumption and housing from the Australian Bureau of Statistics 2009-2010 Survey. The model fits the characteristics of the data well to explain the behavior of Australian retirees. The key findings are the following:

First, the optimal policy is highly sensitive to means-tested Age Pension early in retirement but this sensitivity fades with age.

Secondly, the allocation to risky assets shows a complex relationship with the means-tested Age Pension that disappears once minimum withdrawal rules are enforced. As a general rule, when wealth decreases the proportion allocated to risky assets increases, due to the Age Pension working as a buffer against investment losses.

Finally, couples can be more aggressive with risky allocations due to their longer life expectancy compared with singles.

Keywords: Dynamic programming, Stochastic control, Optimal policy, Retirement, Means-tested age pension, Defined contribution pension

JEL Classification: D14, D91, G11, C61

Suggested Citation

Andreasson, Johan and Shevchenko, Pavel V. and Novikov, Alex, Optimal Consumption, Investment and Housing with Means-Tested Public Pension in Retirement (July 11, 2016). Available at SSRN: https://ssrn.com/abstract=2800907 or http://dx.doi.org/10.2139/ssrn.2800907

Johan Andreasson (Contact Author)

University of Technology Sydney (UTS) ( email )

15 Broadway, Ultimo
PO Box 123
Sydney, NSW 2007
Australia

CSIRO Australia ( email )

41 Boggo Rd
Dutton Park, Queensland
Australia

Pavel V. Shevchenko

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109
Australia

HOME PAGE: http://www.businessandeconomics.mq.edu.au/contact_the_faculty/all_fbe_staff/pavel_shevchenko

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Alex Novikov

University of Technology Sydney (UTS) ( email )

15 Broadway, Ultimo
PO Box 123
Sydney, NSW 2007
Australia

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