Portfolio Management and Retirement: What is the Best Arrangement for a Family?
Financial Markets and Portfolio Management, Vol. 20, No. 1, pp. 265-285, 2006
Posted: 17 Sep 2006
In comparing an immediate life annuity with a payout-equivalent investment fund payout plan (self-annuitization), research to date has focused mainly on shortfall probabilities of self-annuitization. As an exception, Schmeiser and Post (2005) propose a family strategy where the chances of self-annuitization (i.e., bequests) are taken into consideration as well. In such a family strategy, potential heirs must bear shortfall risks, but in return have a chance of receiving a bequest. This paper analyzes under which conditions heirs will be willing to agree to a family strategy. The idea of a family strategy is integrated into a realistically calibrated intertemporal expected utility framework, taking into account risks arising from stochastic life span, asset returns, and nontradable labor income. A family strategy is shown to be accepted for many parameter combinations, especially in families with low marginal tax rates, if the heirs are wealthy, or in a case where the retiree has an average population life expectancy. We also work out how family self-annuitization decisions interact with asset allocation, saving decisions, and labor income risk. Under realistic conditions our results support two explanations for the empirically observable low demand for annuities (the so-called annuity puzzle), namely intra-family risk sharing and high cost of market-annuitization.
Keywords: Self-annuitization, Life-cycle asset allocation, Savings behavior, Retirement decisions
JEL Classification: D13, D14, D91, G11, G22, G23
Suggested Citation: Suggested Citation