It’s a classic conundrum from behavioral finance. Annuitizing retirement plan balances to create lifetime guaranteed income can help retirees address the risk of outliving at least one source of income. Admittedly, annuities have their drawbacks, such as long-term purchasing power decline and a lack of flexibility for bequests, but still, it’s difficult to understand low annuitization rates.
This is the classic “annuitization puzzle,” first described by economist Franco Modigliani in the mid-80s. Despite the retirement income benefits that annuitization provide, it has been and remains a relatively unpopular option. For example, it’s estimated that between half to three-quarters of retirees in defined benefit plans take lump sum distributions when that option is offered, even though an annuity payout is the default option. Among defined contribution plans, research indicates that only 10 percent of plan participants who leave after age 65 take the annuity option.
One cause is a lack of access to plan-based annuities. According to a 2014 survey by consulting firm Towers Watson, only 12 percent of the large- and medium-sized employers surveyed offered a lifetime income option within the company’s retirement plan. A primary reason reported for that low offer rate is a lack of employee interest, according to 57 percent of the respondents. Even when workers have access to a lifetime income option, only 5 percent use it, according to the survey.
Perhaps employee attitudes are changing, though. A new survey from TIAA-CREF reveals that Americans understand the importance of receiving guaranteed monthly income in retirement. However, their strategy for achieving that goal may be missing the mark: The vast majority of Americans (84 percent) said that having a guaranteed monthly paycheck in their post-career years is important, yet only 14 percent have taken steps to ensure lifetime income with the purchase of an annuity.