Optimal Decumulation Strategies During Retirement with Deferred Annuities

Abstract

Since greater flexibility in accessing pension savings has been given to defined contribution pensioners, retirees are in need of advice on how to spend down their savings to make retirement income last throughout their lifetime. Deferred annuities have been discussed extensively in recent years as a retirement solution and have been recommended in the OECD Roadmap for the Good Design of Defined Contribution Pension Plans (OECD2016). Assuming a world where deferred annuities are available, we propose two utility maximising decumulation strategies comprising a deferred annuity purchased at retirement and optimal consumption and savings before the commencement of the annuity. A retiree who is concerned about longevity risk and wants to retain a certain level of liquidity is advised to spend 21.6% on a 15-year deferred annuity or 9.13% on a 20-year deferred annuity. A retiree who simply wants to use annuities to maximise overall satisfaction from retirement consumption is advised to spend 61.83% on a 6-year deferred annuity. We compare our strategies with other available decumulation strategies in the market, hence verifying the merits of the design. Moreover, the stability of our results are examined after allowing for consumption smoothness, social income benefits, a target replacement ratio and a bequest motive.