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Retirement Planning > Retirement Investing

Still working on the annuity puzzle

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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.

Another factor that may increase annuitization in the near future is changes in federal regulations. First, in-plan qualified longevity annuity contracts—QLACs—will become more widely available. Second, the decision to allow annuities within target-date funds could make it easier for participants to consider the annuity option.

In the meantime, however, some plans have much higher annuitization rates and those cases provide insights into retirees’ decision-making processes. At TIAA-CREF, which provides retirement plans to employees of educational and non-profit institutions, the annuitization rate been holding at about 40 percent, according to Ed Moslander, senior managing director and head of institutional client services at the firm in New York City. That figure has increased from about 30 percent in 2009, he says. He cites several possible reasons behind the recent rise and the overall high rate. Recently, the economic uncertainty that dominated in 2008-2009 possibly led retirees to seek greater income security, he speculates. From a historical perspective, most employees in higher education and non-profits did not participate in defined benefit plans. Consequently, they viewed their 403(b) accounts as a primary source of retirement income, unlike 401(k) plans, which many consider a wealth accumulation vehicle. That viewpoint meant that annuitizing at least part of their 403(b) plan balance was a natural progression for many retirees.

TIAA-CREF’s research into the annuitization decision provides additional insights. A 2010 study highlights several that advisors should consider:

  • Investing in retirement plan annuities during the working years influences the annuitization decision: “Retirees who have annuitized their retirement savings are more than twice as likely, compared with retirees who have not annuitized, to have saved through an annuity in a DC plan while working.”
  • For clients working with an advisor, the advisor’s perspective on annuitization matters: “Over one-half of retirees who have not annuitized have worked with a financial advisor and most of these tend to follow the advice received. But only 5 percent were advised to annuitize. By contrast, 71 percent of annuitized retirees report working with a financial advisor in deciding to purchase an annuity or implementing the buy decision.”
  • Annuitants are satisfied with their decision: “57 percent of annuitants are very satisfied with the decision to purchase a payout annuity and an additional 32 percent are somewhat satisfied.”


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