401(k) Investors With Annuities Are Less Likely to Trade

Guaranteed lifetime income, and annuities in particular, commonly are viewed as a way to simplify decisions around generating income in retirement.

There are a myriad of assumptions, and uncertainties, related to withdrawing money from a portfolio in retirement. Allocating to products that provide guaranteed lifetime income is one way retirees can ensure that no matter how they live, they will have something to live on.

While most of my research on guaranteed lifetime income has focused on the economic benefits of the approach, there are other important behavioral considerations as well.

For example, in some ongoing research with Michael Finke, which we summarized for ThinkAdvisor, we found that retirees who have more of their total economic worth in guaranteed income tend to spend more in retirement.

In other words, guaranteed income provides retirees with a “license to spend” compared to a more traditional portfolio.

Inside the Numbers

In some new research, where I reviewed the trading activity of defined contribution (i.e., 401(k)) participants in 2020, I also found that those who had an allocation to an annuity that provided guaranteed lifetime income (a variable annuity with a guaranteed lifetime withdrawal benefit, or GLWB, to be more precise) were less likely to trade than those who were just invested in the funds available on the core menu.

The effect was statistically significant at the .1% level and I control for the investor-type as part of the analysis (see Appendix 4 if you want to see the specific regression results), so the findings are definitely robust.

The specific age cohort reviewed for this guaranteed income analysis was participants age 55 to 70.  As part of the analysis I also found that older participants were more likely to transact.

While I don’t know exactly why allocating to guaranteed income resulted in reduced trading, my guess is that participants who had a higher allocation to guaranteed income were less concerned about the market volatility because of the inherent certainty around lifetime income as part of the GLWB.

While I doubt most participants fully understand the payout structure of GLWBs, participants likely had at least some sense of the fundamental guarantee associated with the product.

Therefore, the impact of a negative market event likely was viewed as less severe among participants who had a GLWB allocation than those without, which is why those participants were less likely to trade.

Advisor Action

What does this mean for advisors?  Well, the analysis demonstrates an additional potential “behavioral” benefit associated with allocating to guaranteed income: It can make participants more likely to stick with their portfolio during times of higher volatility.

While many advisors would suggest that is fundamentally their job (to prevent the client from overreacting to market volatility), the client can always fire the advisor (and then make the trades), or threaten to do so unless action is taken.

In other words, creating a strategy that reduces trading impulses by clients potentially benefits both the client and the advisor.

At its core, this general finding is being very much related to the “License to Spend” research, because it suggests there is a different dimension of risk with more traditional investments (think mutual funds and ETFs) that simply doesn’t exist with guaranteed income: the potential risk of being broke at some unknown point in the future.

Advisors looking to create a well-rounded plan should consider annuities when creating retirement income strategies.

While it’s certainly true that not everyone needs to purchase an annuity, and that most Americans can likely get enough guaranteed lifetime income by delayed claiming of Social Security retirement benefits, there are a number of complex behavioral issues you can’t solve with a portfolio alone, no matter how “efficient” or “optimized” you think it may be.

In summary, there are a number of important behavioral benefits associated with allocating to guaranteed income that should be considered when creating truly holistic retirement income strategies.

David Blanchett is managing director and head of retirement research at PGIM DC solutions.