Optimal investment for a retirement plan with deferred annuities

Owadally, Iqbal; Jang, Chul; Clare, Andrew

Abstract

We construct an optimal investment portfolio model with deferred annuities for an individual investor saving in a retirement plan. The objective function consists of power utility in terms of consumption of all secured retirement income from the deferred annuity purchases, as well as bequest from remaining wealth invested in equity, bond, and cash funds. The asset universe is governed by a vector autoregressive model incorporating the Nelson–Siegel term structure and equity returns. We use multi-stage stochastic programming to solve the optimization problem numerically. Deferred annuity purchases are made continuously over the working lifetime of the investor, increasing particularly in the years before retirement. The investment strategy hedges price changes in deferred annuities, and bond holding and deferred annuity purchases increase when interest rates are high. Optimal investment and deferred annuity choices depend on realized and expected values of state variables. The optimal strategy is also compared with typical retirement plan strategies such as glide paths. Our results provide support for deferred annuities as a major source of retirement income.

• Journal Article Type: Article
• Acceptance Date: Feb 3, 2021
• Online Publication Date: Feb 15, 2021
• Publication Date: May 1, 2021
• Deposit Date: May 20, 2024
• Publicly Available Date: May 22, 2024
• Journal: Insurance: Mathematics and Economics
• Print ISSN: 0167-6687
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 98
• Pages: 51-62
• DOI: https://doi.org/10.1016/j.insmatheco.2021.02.001
• Keywords: Stochastic programming, Retirement planning, Deferred annuities, Nelson-Siegel model, Vector autoregressive, Glide path
• Public URL: https://nottingham-repository.worktribe.com/output/34871583
• Publisher URL: https://www.sciencedirect.com/science/article/pii/S0167668721000196?via%3Dihub
• Additional Information: This article is maintained by: Elsevier; Article Title: Optimal investment for a retirement plan with deferred annuities; Journal Title: Insurance: Mathematics and Economics; CrossRef DOI link to publisher maintained version: https://doi.org/10.1016/j.insmatheco.2021.02.001