Optimal annuitisation, housing and reverse mortgage in retirement in the presence of a means-tested public pension

Abstract

AbstractIn this paper we develop a model to find optimal decisions in retirement with respect to the consumption, risky asset allocation, access to annuities, reverse mortgage and the option to scale housing in the presence of a means-tested public pension. To solve the corresponding high-dimensional optimal stochastic control problem, we use the Least-Squares Monte Carlo simulation method. The model is applied in the context of the Australian retirement system. Few retirees in Australia utilise financial products in retirement, such as annuities or reverse mortgages. Since the government-provided means-tested Age Pension in Australia is an indirect annuity stream which is typically higher than the consumption floor, it can be argued that this could be the reason why many Australians do not annuitise. In addition, in Australia where assets allocated to the family home are not included in the means tests of Age Pension, the incentive to over-allocate wealth into housing assets is high. This raises the question whether a retiree is really better off over-allocating into the family home, while accessing home equity later on either via downsizing housing or by taking out a reverse mortgage. Our findings confirm that means-tested pension crowds out voluntary annuitisation in retirement, and that annuitisation is optimal sooner rather than later once retired. We find that it is never optimal to downscale housing when the means-tested pension and a reverse mortgage are available; only when there is no other way to access equity then downsizing is the only option.