MOTOHIRO YOGO, University of Pennsylvania - Finance Department, National Bureau of Economic Research
Email: yogo@wharton.upenn.edu

This paper develops a consumption and portfolio-choice model of a retiree who allocates wealth in four asset classes: a riskless bond, a risky asset, a real annuity, and housing. The retiree chooses health expenditure endogenously in response to stochastic depreciation of health. The model is calibrated to explain the joint dynamics of health expenditure, health, and asset allocation for retirees in the Health and Retirement Study, aged 65 and older. The calibrated model is used to assess the welfare gain from private annuitization. The welfare gain ranges from 13 percent of wealth at age 65 for those in worst health, to 18 percent for those in best health.

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HANS FEHR, University of Würzburg - Institute of Economics and Social Sciences
Email: hans.fehr@mail.uni-wuerzburg.de
FABIAN KINDERMANN, affiliation not provided to SSRN

The present paper studies the growth and efficiency consequences of pension funding with individual retirement accounts in a general equilibrium overlapping generations model with idiosyncratic lifespan and labor income uncertainty. We distinguish between economies with rational and hyperbolic consumers and compare the consequences of voluntary and mandatory retirement plans. Three major findings are derived in our study: First, we quantify the commitment effect of social security for myopic individuals by roughly 1 percent of aggregate resources. It is possible to recapture this commitment technology in IRAs, if those are annuitized. Second, despite the fact that our consumers have an operative bequest motive, the welfare gain from the (implicit) longevity insurance of the pension system is significant and amounts to roughly 0.5 percent of aggregate resources. However, mandatory annuitization reduces unintended bequests so that future generations are significantly hurt. Finally, our results highlight the importance of liquidity effects for social security analysis. These efficiency gains are only attainable if accounts are voluntary and not mandatory.

RAIMOND MAURER, University of Frankfurt - Faculty of Business and Economics
Email: Rmaurer@wiwi.uni-frankfurt.de
OLIVIA S. MITCHELL, University of Pennsylvania - Insurance & Risk Management Department, National Bureau of Economic Research (NBER)
Email: mitchelo@wharton.upenn.edu
RALPH ROGALLA, Goethe University Frankfurt - Department of Finance
Email: rogalla@wiwi.uni-frankfurt.de

This paper examines how labor income volatility and social security benefits influence life-cycle household portfolios. We examine how much the individual saves, and where, taking into account liquid financial wealth and annuities, and stocks versus bonds. Higher labor income uncertainty and lower old-age benefits boost demand for stable income in retirement, but also when young. In addition, a declining equity glide path with age is appropriate for the worker with low income uncertainty but for the high income risk worker, equity exposure rises until retirement. We also evaluate how changes in social security benefits influence retirement risk management.

BENJAMIN AVANZI, Australian School of Business at UNSW
Email: b.avanzi@unsw.edu.au
SACHI PURCAL, University of New South Wales - School of Actuarial Studies
Email: s.purcal@unsw.edu.au

We adopt a two-tiered economic approach to classify national retirement savings schemes. We extend the plain vanilla system of forced savings by allowing for annuitisation and cross-subsidies. The first tier of our model is controlled by government, which mandates contribution rates, interest rates, and conversion into benefits. In contrast, agents make voluntary contributions in the second tier, which earn interest at a rate broadly reflecting market conditions and any cross-subsidy between both tiers. Cross-subsidies within the mandated tier and between both tiers allow for social redistribution as well as the creation of a liquid market of privately provided annuities. We conclude with a discussion of the Swiss and Australian systems of retirement savings as seen through the lens of our model.

ROGER GAY, Monash University
Email: roger.gay@buseco.monash.edu.au

Signals emanating from the Henry Review of Taxation indicate that the government is considering selling life annuities to retirees. All available evidence suggests that self-funding retirees generally are not prepared to relinquish control of their capital and are not interested in purchasing life annuities. There may however be another way to their hearts and purse strings, in the light of retirement account losses due to the GFC. The best way to convert a retirement lump sum into an income stream is to split the sum into two parts. One part - ‘cash’- is used to purchase a guaranteed income stream in the medium term (ten or twelve years). The remainder is invested in the best-performing portfolio of risky assets. This ‘market portfolio’ can be expected to replace the entire original capital in real terms over the guaranteed income years, enabling the strategy or a modified version of it to be repeated. Under the mean-variance criterion this strategy cannot be improved upon. It is less risky than taking a pension by drawdown from a New Pension, and is more likely to preserve the capital in the face of longevity provided a prudent annual pension is taken. The difficulty at present is that annuities must be purchased from commercial providers with attendant default risk. This shortcoming could easily be overcome if governments were to provide annuity or indexed annuity bonds as part of its publicly issued debt.

DANIEL G. GOLDSTEIN, London Business School
Email: dgoldstein@london.edu
ERIC J. JOHNSON, Columbia University - Columbia Business School
Email: ejj3@columbia.edu
WILLIAM F. SHARPE, Stanford University - Graduate School of Business, National Bureau of Economic Research (NBER)
Email: wfsharpe@stanford.edu

Investing for retirement is one of the most consequential yet daunting decisions consumers face. We present a way to both aid and understand consumers as they construct preferences for retirement income. The method enables consumers to build desired probability distributions of wealth constrained by market forces and the amount invested. We collect desired wealth distributions from a sample of working adults, provide evidence of the technique's reliability and predictive validity, characterize individual- and cluster-level differences, and estimate parameters of risk aversion and loss aversion. We discuss how such an interactive method might help people construct more informed preferences.