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Optimal Asset Allocation towards the End of the Life Cycle: To Annuitize or Not to Annuitize?

Moshe Arye Milevsky
The Journal of Risk and Insurance
Vol. 65, No. 3 (Sep., 1998), pp. 401-426
DOI: 10.2307/253657
Stable URL: http://www.jstor.org/stable/253657
Page Count: 26
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Optimal Asset Allocation towards the End of the Life Cycle: To Annuitize or Not to Annuitize?
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Abstract

Most individuals must decide how much of their marketable wealth should be annuitized at retirement. The natural alternative to annuitization is investing the wealth and withdrawing the exact same consumption stream as the annuity would have provided. Of course, this strategy risks under-funding retirement in the event of below average investment returns with above average longevity. This paper develops the framework for a third alternative. We propose a model in which retirees defer annuitization, via a "do-it-yourself" scheme, until it is no longer possible to beat the mortality-adjusted rate of return from a life annuity. We make use of a unique Canadian database to calibrate the insurance loads and interest rate parameters. We conclude that in the current environment, a sixty five year old female (male) has a ninety percent (eighty-five percent) chance of beating the rate of return from a life annuity, until age eighty.

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