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At, in, or near retirement, investors need to make specific decisions about how they are going to use their savings to generate income during retirement and meet their estate goals when they die. If they withdraw too much each year for spending needs, they face the risk of running out of assets before they die. This is often called "longevity risk." If they withdraw too little, they may not be able to meet their immediate expenses and support a certain lifestyle. Investors also need to decide how to invest their savings among asset classes and annuities.
Retirement income management is choosing a combination of annuity, withdrawal, and investment strategies such that it is unlikely that the investor will run out of money before death while achieving the investor's financial goals. In making these decisions, the investor must manage both market risk and longevity risk.
There are no simple answers to these questions, and the optimal results will vary depending on the investors age, assets, income, and family/marital situation. Some advisors rely on rules of thumb to advise clients on these matters. For example, some employ the rule that investors withdraw no more than 5% of their savings each year.
In this article, we explore retirement income solutions in a simple setting to illustrate the trade-ofis that retired investors face regarding how much income they can generate, how much short-term risk they are exposed to, how large an estate they can expect to leave, and how likely they are not to run out of assets before dying (the "success" probability). This article contributes to the existing research by simultaneously considering the following factors:
* the percentage of assets to withdraw each year
* the proportion of the assets to invest in immediate fixed annuities as opposed to other assets
* the impact of inflation on fixed annuity payouts
* asset allocation for the non-annuitized assets
We assume that at the beginning of the retirement period, the investor chooses how much annual income to generate (in real dollars), how much to invest in single-premium immediate annuities, and what asset mix to use to manage non-annuitized assets.
We use a Monte Carlo simulation approach to solve the model for the probability of not running out of money...