Data and Research

Research Finds Benefit of Offering Longevity Annuities in DC Plans

The researchers conclude that “including well-designed LIA defaults in DC plans yields quite positive consequences for …workers.”

By Rebecca Moore | July 17, 2017

Research finds that defined contribution (DC) retirement plan participants can gain retirement wealth from the offering of a longevity annuity within their plans.

In 2014, the Treasury Department issued final rules easing required minimum distribution (RMD) requirements that have made it difficult for retirees to purchase and hold longevity annuity products without jeopardizing the qualified status of their retirement accounts.  Longevity income annuities are deferred life annuities that start payouts on or before age 85.

Researchers from the finance department at Goethe University and from the Wharton School at the University of Pennsylvania developed a model to quantify the impact of the availability of longevity annuity contracts for a range of retiree types. They first found that introducing a longevity income annuity (LIA) into the DC plan investment menu is attractive to the majority of plan participants. Overall, older individuals would commit 8% to 15% of plan balances at age 65 to an LIA that begins payouts at age 85.

When participants can select their own optimal annuitization rates, welfare increases by 5% to 20% of average retirement plan accruals as of age 66 compared to not having access to LIAs. If plan sponsors defaulted participants into an LIA using 10% of their retirement age plan assets, this would only slightly reduce the participants well-being in retirement compared to the optimum, the researchers found.

According to the research paper, results are less positive for those with higher mortality than the average. Using a default rule for these individuals generates lower retirement welfare since annuity prices based on average mortality rates are too high. However, converting assets into an LIA only for those with balances greater than $65,000 overcomes this problem.

The researchers conclude that “including well-designed LIA defaults in DC plans yields quite positive consequences for …workers.” They say their findings also apply to individual retirement account (IRA) payout designs.