Optimal Gradual Annuitization: Quantifying the Costs of Switching to Annuities

Wolfram Horneff (), Raimond Maurer () and Michael Stamos ()

No 174, Working Paper Series: Finance and Accounting from Department of Finance, Goethe University Frankfurt am Main

Abstract: We compute the optimal dynamic annuitization and asset allocation policy for a retiree with Epstein/Zin preferences, uncertain investment horizon, potential bequest motives, and pre-existing pension income. In our setting the retiree can decide each year how much he consumes and how much he invests in stocks, bonds, and life annuities, while the prior literature mostly considered restricted so-called deterministic or stochastic switching strategies. We show that postponing the annuity purchase is no longer optimal in the gradual annuitization case since investors are able to attain the optimal mix between liquid assets (stocks and bonds) and illiquid life-annuities each year. In order to assess potential utility losses, we benchmark various restricted annuitization strategies against the unrestricted gradual annuitization strategy.

JEL-codes: D91 G11 G22 H55 J26 (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-pbe and nep-upt
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