Looking At The Value Of Annuitization

A seminar here on retirement in America looked at questions that many consumers are starting to ask as they consider their own retirement and then seek to answer those questions.

The session, titled “Retirement In America: What’s Next? What Do We Do Now?” was sponsored by Barclays Global Investors, based in San Francisco.

Among possible solutions discussed were working longer, saving more and using annuitization to relieve the amount of savings that will be required.

The session kicked off with an overview of recent trends in the U.S. retirement area presented by Dallas Salisbury, president and CEO of the Employee Benefit Research Institute, Washington.

Citing the 2002 annuity mortality table, Salisbury noted that males age 65 have a 50% chance of living to age 85 and a 25% chance of living to age 92. For females, the respective numbers are a 50% chance of living to age 88 and a 25% chance of living to age 94. For couples, there is a 50% chance of one survivor living to age 92 and a 25% chance of one living to age 97.

One problem, he noted, is that people think life expectancy represents the end of life and do not understand that it is a median age.

The trend toward longer life and what that costs is being pressured by other trends including the growth of health care costs as a percentage of total benefit dollars spent, he explained. As evidence, Salisbury cited statistics from EBRI based on data from the U.S. Department of Commerce which indicate that as a percentage, health care expenses grew to 41.2% of benefit dollars in 2004 from 14.2% in 1960.

Salisbury also discussed the value of annuitization, noting that it “can allow you to save 34% less than if you try to do it yourself, on average.” The average life expectancy for a male at 65 is now 81, he noted. So, he explained, if you annuitized your savings at 65, you could do that by having saved about 8% of income from ages 20 to 67, 16% from ages 40 to 67, or 27% from ages 50-67. However, Salisbury continued, if you were to do it yourself without an annuity and actually lived to 100, you would have to save 13% from ages 20-67.

Risk of running out of money

Olivia Mitchell, Ph.D., a professor of insurance and risk management at the Wharton School of the University of Pennsylvania, reiterated the need to address the risk of running out of money in retirement.

That risk is broken out into factors that include undersaving, living too long, and having health problems, she explained.

What can help alleviate that problem, she said, is to work longer. An American in the median wage quintile would need an additional 17.3% of savings to replace income if that person retired at age 62 but only 7.7% of income if that person retired at age 65.

“Annuities are a very undervalued product,” she noted. “There are good ones and bad ones, but in principle, they are very important.”