Sent: 15-09-2009 11:47:02
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Retire, then what - 2
Last time I referred to a report from Wharton concerning a conference focusing on the post retirement years and how people manage their finances. I will be continuing with that theme in this article.
Much of the conference research touched on how to avoid outliving assets in retirement. Olivier Mitchell, executive director of Wharton's Pension Research Council, commented that accumulation type annuity products have been around a long time, but little attention has been devoted to payout annuities. As she said, "Now that boomers are reaching the crucial realization that retirement is no longer a dream but soon a reality, the question arises as to how people will avoid outliving their assets."
What they found was that inflation-linked lifetime income annuity products have become an important part in many boomer portfolios. However, as she went on to comment, the challenge is to get boomers to understand how long they may actually survive in retirement, and then how to protect against living too long. As she so rightly says, only then will it be possible to get boomers to take longevity risk seriously.
I recall previous work that I was associated with looking at why people did not like the idea of annuities. More recent research in the US found a number of reasons why people do not like annuities, i.e.
- A perception that they are expensive
- A desire to pass savings on to their children/grandchildren
- A desire for liquidity to allow for unexpected costs such as unforeseen medical expenses etc.
- The tendency to defer thinking about death
- Reliance on welfare benefits
- The perceived lack of inflation protection.
The above list is remarkably similar to our findings in Australia. I also recall that many/most people had little or no understanding of annuities with the major concern being that the provider would simply take all their money leaving nothing for them to pass on. Sadly I doubt this lack of knowledge has changed very much since that time.
However, a radically new approach was suggested by William Sharpe (as in the winner of the Nobel Prize in Economics). He argued that traditional retirement security strategies are split into two parts: an investment strategy and a spending policy. He argued that these actually need to be interlocked and integrated suggesting that if they are not, it is not possible to achieve results that are as good as the client deserves.
Sharpe's research team proposed a "lockbox" strategy in which fractions of initial wealth are allocated to virtual accounts, or lockboxes. The money in each lockbox is independently invested, and each year the retiree spends only the contents of that lockbox designated for that year. He explained that "the point is that each lockbox has a strategy which is efficient vis-a-vis its year of maturity. Therefore, the whole thing is efficient."
Sharpe said the "lockbox" concept also protects against age-related problems in savings and retirement spending. "The lockbox maximizes my expected utility at my current age versus 20 years older, or dead. I don't want to wait until I get there because I'll be drooling and I won't know what utility it is. It allows me to think now about the future me and act in loco parentis for my senile and elderly self."
Definitely a different approach and one that deserves thinking about, especially given who is proposing it.
Finally, in her concluding comments, Olivier Mitchell noted deferred annuities have been mandated by the government in Germany and the UK, to protect people against running out of money too soon. It is also worth remembering that Australia is one of the few countries that pays out its retirement benefits as a lump sum and then allows people to do what they wish with it. I would suggest that the approach has to change but whether it does is another matter as it will take a significant amount of backbone for politicians to change the current practice.
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