Retirement Income Showdown: Risk Pooling vs. Risk Premium

17 Pages Posted: 29 Oct 2016

See all articles by Wade D. Pfau

Wade D. Pfau

The American College; McLean Asset Management

Date Written: October 28, 2016

Abstract

The retirement income showdown regards finding the most efficient approach for meeting retirement spending goals: obtaining mortality credits through risk pooling with an income annuity, or investing for upside growth through the stock risk premium. Analyzing the question involves understanding how clients view a hierarchy of retirement goals related to spending, liquidity and legacy. Client attitudes toward longevity risk aversion also matter: how fearful is the client of outliving their investment portfolio? Risk pooling offers a unique source of returns not available from an investment portfolio: those in the risk pool who experience shorter lives subsidize the payments to those in the pool who experience longer lives (mortality credits). Risk pooling may provide a cheaper way to meet a spending goal, leaving more assets to cover contingencies and support legacy. The primary advantage of an investments-only strategy is that it can support greater legacy in the short-term compared to a partial-annuitization strategy that uses risk pooling to meet spending goals and investments to meet liquidity and legacy goals. Risk averse retirees, though, may feel obligated to earmark a larger portion of their portfolio to spending goals, which leaves less true liquidity, while also exposing the spending goal to the risk of portfolio depletion. The advantages of risk pooling include a contractual guarantee to support lifetime spending, the ability to meet spending goals with a smaller portion of assets that creates greater true liquidity for the retirement income plan, and the potential to support a larger legacy in the event of a long life.

Keywords: retirement planning, income annuity, risk premium, investments

JEL Classification: D14

Suggested Citation

Pfau, Wade D., Retirement Income Showdown: Risk Pooling vs. Risk Premium (October 28, 2016). Available at SSRN: https://ssrn.com/abstract=2860775 or http://dx.doi.org/10.2139/ssrn.2860775

Wade D. Pfau (Contact Author)

The American College ( email )

Bryn Mawr, PA 19010
United States

HOME PAGE: http://www.retirementresearcher.com

McLean Asset Management ( email )

8200 Greensboro Dr
# 1150
McLean, VA
United States

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