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The shortfall risk and investment risk of systematic withdrawal[17-05]
Author(s)
Wonku Hong
The date
28 February 2017
Publications
Pensions
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The Korean retirement pensions are not required to pay retirement benefit as an annuity. It is up to the retiree's decision to withdraw retirement asset as a lump sum, or as an annuity. Therefore, retirement assets may be used for other purposes than retirement income. This is a critical limitation on the role of retirement pensions as the main source of retirement income.
The percentage of people choosing a life annuity is not high due to various factors. This study focuses on the absolute size and the relative size of retirement pension assets. In other words, retirement pension assets up to now are small and relatively small compared to pension assets already held as the national pension. The small size of retirement pension assets may reduce the possibility to choose the annuity. Using the analysis of the Annuity Equivalent Wealth(AEW), this study shows that as the proportion of life annuities other than retirement pensions such as the national pension increases, the AEW becomes relatively small. Thus, as retirement wealth increases, the percentage of retirees who choose annuity will increase. On the other hand, as the retirement age increases, the AEW increases. The higher the actual retirement age of the workers, the higher the rate of selecting annuity. 
When retirees withdraw retirement pension assets, they can choose various withdrawal rates, that is, withdrawal amounts. Using the Stochastic Present Value model, this study compares the shortfall probability of various withdrawal methods with different amounts of withdrawal and risky assets. Generally, the lower withdrawal amount, the higher rate of returns of retirement assets, the lower return volatility leads to the lower the shortfall probability. Active asset management plays an important role in reducing the shortfall probability. In other words, the shortfall probability drops when investing a certain percentage of retirement assets in risky assets, though the size of reduction will depend on the difference between the return on risky assets and the return on risk-free assets. On the other hand, retirees can purchase a life annuity to eliminate the shortfall risk, that is, to eliminate the risk of longevity. In this case, the withdrawal amount becomes smaller.
The ultimate goal of retirement plans is to secure retirement income. As retirement pension assets gradually increase, the rate of selecting annuity will increase. In order to encourage systematic partial withdrawal, it is necessary to restrain the withdrawal before retirement. Taxing the lump sum at the same way as the general income can also increase the systematic withdrawal. On the other hand, the sustainability of partial withdrawals largely depends on the risk and return of investment. Therefore, retirees need to find a balance between risk and return. The role of financial investment companies is to provide products that can help these retirees' efforts. In addition, reliable investment advisers should be nurtured to help retirees manage retirement assets and select products.
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