Optimal Annuitisation, Housing Decisions and Means-Tested Public Pension in Retirement Under Expected Utility Stochastic Control Framework

30 Pages Posted: 21 May 2018 Last revised: 23 Dec 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

Date Written: December 16, 2018

Abstract

In this paper, we develop a retirement model under the expected utility stochastic control framework to find optimal decisions with respect to consumption, risky asset allocation, access to annuities, reverse mortgage and the option to scale housing. The model is solved numerically using Least-Squares Monte Carlo method adapted to handle expected utility stochastic control problem in high dimensions. To demonstrate the applicability of the framework, the model is applied in the context of the Australian retirement system. Few retirees in Australia utilise financial products in retirement, such as annuities or reverse mortgages. Since the government-provided means-tested Age Pension in Australia is an indirect annuity stream which typically is higher than the average consumption floor, it is argued that this is the reason why Australians do not annuitise. In addition, in Australia where assets allocated to the family home are not included in the means tests of Age Pension, the incentive to over allocate wealth into housing assets is high. This raises the question whether a retiree is really better off over allocating into the family home, while accessing home equity later on either via downsizing housing or by taking out a reverse mortgage. Our findings confirm that means-tested pension crowds out voluntary annuitisation in retirement, and that annuitisation is optimal sooner rather than later once retired. We find that it is never optimal to downscale housing with the means-tested Age Pension when a reverse mortgage is available, only when there is no other way to access equity then downsizing is the only option.

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., Optimal Annuitisation, Housing Decisions and Means-Tested Public Pension in Retirement Under Expected Utility Stochastic Control Framework (December 16, 2018). Macquarie University Faculty of Business & Economics Research Paper. Available at SSRN: https://ssrn.com/abstract=3174459 or http://dx.doi.org/10.2139/ssrn.3174459

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

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