Portfolio Management and Retirement : What is the Best Arragement for a Family?

In comparing an immediate life annuity with a payout-equivalent investment fundpayout plan (self-annuitization), research to date has focused mainly on shortfallprobabilities of self-annuitization. As an exception, Schmeiser and Post (2005)propose a family strategy where the chances of self-annuitization (i.e., bequests)are taken into consideration as well. In such a family strategy, potential heirs mustbear shortfall risks, but in return have a chance of receiving a bequest. This paperanalyzes under which conditions heirs will be willing to agree to a family strategy.The idea of a family strategy is integrated into a realistically calibrated intertemporalexpected utility framework taking into account risks arising from stochastic lifespan, asset returns, and nontradable labor income. A family strategy is shown to beaccepted for many parameter combinations, especially in families with low marginaltax rates, if the heirs are wealthy, or in a case where the retiree has an averagepopulation life expectancy. We also work out how family self-annuitization decisionsinteract with asset allocation, saving decisions and labor income risk. Underrealistic conditions our results support two explanations for the empirically observablelow demand for annuities (the so-called annuity puzzle), namely intra-familyrisk sharing and high cost of market-annuitization.