One valuable part of CPP, OAS, and defined-benefit pensions is that they keep paying you even if you live a long life. In more technical language, these pensions take care of longevity risk. When you have to manage your own investments, you’re forced to spend conservatively in retirement in case you live long. Here we consider example cases to illustrate the cost of longevity risk. Shawna is 65 years old and is entitled to a $1000 per month pension, indexed to inflation, for the rest of her life. She is offered the choice of keeping this pension or withdrawing its commuted value to invest in her locked-in retirement account. To keep this example simple, we’ll assume the pension plan expects Shawna to live 20 more years, and her commuted value is calculated with a discount rate of inflation plus 1.5%. The commuted value of her pension works out to $207,436. We’ll also assume Shawna won’t have to pay any income taxes immediately as she would have to if her commuted value was t...

When I retire I’d like to be able to invest in a fund holding a low-cost index of the world’s stocks that addresses longevity risk. The idea is that it would be like a low-cost annuity based on stock returns rather than bond returns. The easiest way to describe this idea is first as a simple tontine structure. Imagine a large number of 65-year old women each placing $100,000 into a fund and the money gets invested in a low-cost index of the world’s stocks. Each month the fund sells some fraction of the shares and divides the money among the surviving women. The dollar value of shares the fund sells would be chosen based on expected stock market returns and mortality expectations. The payouts would be calculated so that if these expectations turn out exactly right, then the monthly payments would rise exactly with inflation. However, the actual monthly payments would be based on actual stock returns and the actual number of surviving women. No money would go to the estates of ...