How a 401(k) ‘Bridge’ Lets Annuity Haters Delay Social Security Claiming

Annuities may get a lot of attention lately, but for the most part, people aren’t buying them, a new study finds. Noting that the market for annuities is minuscule, researcher from the Center for Retirement Research at Boston College wanted to determine what individuals could do to mimic the “bridge” to Social Security that annuities offer, by using assets from 401(k) accounts.

“Explanations for the low demand include the high cost of private annuities due to adverse selection, a reluctance to hand over a pile of accumulated assets for a stream of future income, and a failure to understand the value of insurance against outliving one’s resources,” authors Alicia H. Munnell, CRR director, and Gal Wettstein, a CRR senior research associate, wrote in “Would 401(k) Participants Use a Social Security “Bridge” Option?”

Using one’s 401(k) assets to delay the need to claim Social Security, thus increasing its payout, has been much discussed by the advisory industry. The study found that a “substantial minority” of 401(k) participants, about a third, were interested in this bridge option, especially if it was a default in their defined contribution account.

“Without some guidance, retirees risk spending too quickly and exhausting their resources or spending too slowly and depriving themselves of necessities,” the authors noted. “They must also decide how to invest their assets.

“For decades, academics have argued that using at least some 401(k) assets to buy an annuity can significantly mitigate these risks,” they noted. “But few plans offer options to annuitize, in part because only a small fraction of participants use them even when they are available.”

Inside the Study

Delaying taking Social Security past full retirement age increases benefits by 8% per year until age 70, so retirees who use a 401(k) assets as a bridge to claiming can essentially “buy a higher Social Security benefit,” according to the authors.

The 1,349 respondents in the online study had at least $25,000 in their 401(k) accounts, were 50 to 65 years old and were not yet retired.

The study looked at four groups: 1) those who were provided limited information on the bridge strategy, 2) those who received “explicit” pros and cons of the bridge, 3) those who received a detailed explanation of the bridge option and 4) those who had the bridge as a default choice, with the ability to opt out or make changes to the allocation.

As the researchers noted, “the potential for enhancing annuity income through Social Security is substantial, since the majority of retirees claim before their [full retirement age] and about 95% claim before age 70,” according to the Social Security Administration.

Breaking the Link

The bridge option would help “break the link between retirement and claiming, since it is designed specifically to allow workers to exit the labor force without simultaneously claiming benefits,” the authors stated.

The bridge would use 401(k) assets equivalent to Social Security payments up to the time the money was depleted or age 70, when retirees could claim their maximum Social Security benefits.

To make the “process as seamless as possible,” the study used the bridge as a default, drawing either 20% or 40% of the worker’s 401(k) assets.

The study assumed an annual return on 401(k) balances of 4.75% and a combined employer-employee contribution rate of 10% of earnings from the respondent’s current age up to retirement.

The third group, which received the most information, was most likely to choose the bridge, with 35% doing so. The least likely were the respondents that received the bare-bones information: the first group, of which 26.8% opted for the bridge.

“The results indicate a substantial interest in the bridge strategy,” the authors noted. “The fact that over one quarter of respondents would adopt the strategy based on such limited information as the control group [1] had is noteworthy.”

They added this was similar to the number of workers who opted for in-plan annuities in a study by TIAA in 2018.

They also found that participants in the fourth group, who were defaulted into the bridge, stated they would allocate 20.4 percentage points more of assets to the strategy than their cohorts in the first group. However, as the authors noted, “merely adding information about the bridge (treatment group 3) does not appear to increase allocation.”

That said, “the results do suggest that those who learn more about the bridge increasingly want to participate in it, albeit at a relatively low intensity,” according to the study.

Implications of the study findings included:

• Misperception of annuities as investments really is a barrier to wider adoption of annuities. “Merely laying out the pros and cons of insurance versus investments leads to substantial increases in annuitization choices, at least in the context of the bridge strategy,” the researchers found.
• A “simple nudge” can “dramatically increase usage of the bridge option.”
• Those who were “defaulted” into the bridge option ended up allocating a far bigger share of their assets to the bridge.