Optimal Strategies for the Decumulation of Retirement Savings under Differing Appetites for Liquidity and Investment Risks

TL;DR

This paper investigates how retirees' varying appetites for liquidity and investment risks influence their optimal decumulation strategies, using a new framework that considers individual risk preferences and real-world Australian market conditions.

Contribution

It introduces a framework that determines optimal decumulation strategies accounting for differing risk appetites, highlighting their significant impact on retirement decision-making.

Findings

Risk appetites significantly affect strategy choice.

Australian context shows preference for non-annuity options.

Framework aligns with observed retiree behaviors.

Abstract

A retiree's appetite for risk is a common input into the lifetime utility models that are traditionally used to find optimal strategies for the decumulation of retirement savings. In this work, we consider a retiree with potentially differing appetites for the key financial risks of decumulation: liquidity risk and investment risk. We set out to determine whether these differing risk appetites have a significant impact on the retiree's optimal choice of decumulation strategy. To do so, we design and implement a framework which selects the optimal decumulation strategy from a general set of admissible strategies in line with a retiree's goals, and under differing appetites for the key risks of decumulation. Overall, we find significant evidence to suggest that a retiree's differing appetites for different decumulation risks will impact their optimal choice of strategy at retirement. Through an illustrative example calibrated to the Australian context, we find results which are consistent with actual behaviours in this jurisdiction (in particular, a shallow market for annuities), which lends support to our framework and may provide some new insight into the so-called annuity puzzle.