The retirement income frontier and its application in constructing investment strategies at retireme

The retirement income frontier and its application in constructing investment strategies at retireme


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Speaker(s): John Anderson (Sygnia Asset Management), Steven Empedocles (Sygnia Asset Management)

The framework we put forward here seeks to address the 'annuity puzzle', a behavioural contradiction observed in practice between individuals' retirement goals and the annuities they typically select at retirement. A significant majority of individuals state that their preference is for a guaranteed income for life, but data from the South African market shows that almost all retirees opt for living annuities (a South African draw-down account that invests in various asset classes and that provides no explicit longevity protection). The framework therefore recognises that, in making the decision to convert accumulated savings into income, individuals have to balance the need to meet their remaining lifetime spending needs with the need for sufficient liquidity to provide for shock events and/or legacies for heirs.

A model specific to South Africa was constructed to determine the lifetime spending needs met and the expected financial reserve upon death, for different strategies combining living and life annuities. 'Lifetime spending needs met' is defined as the probability-weighted proportion of income needs being met over a remaining lifetime with 90% confidence. 'Expected financial reserve upon death' is defined as the 50th percentile of the present value of the remaining retirement assets available on the death of the pensioner, adjusted by the present value of income support provided by dependants during the life of the pensioner to meet their income needs where it fell short. A retirement income frontier is then derived, from various combinations of possible investment strategies, consisting of the strategies with the highest expected financial reserve upon death for each level of lifetime spending needs met. Individuals, advisors and trustees can then select the appropriate strategy on the retirement income frontier that meets their desired levels of lifetime spending needs met and their expected financial reserve upon death.

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