American Retirees Might Be Under-Annuitized

Logic would dictate that retirees would shift their retirement savings to annuity products, but this has yet to happen, a research paper says.

The importance of annuity-like income as a share of income for aged families (those ages 62 and over) is the focus of a paper from the Center for Retirement Research at Boston College.

Contrary to a widespread fear caused by the shift from defined benefit (DB) to defined contribution (DC) retirement plans, there is little evidence that the annuity-like income share of total income over the past three decades has, in fact, fallen for aged families, especially for low-income older families, the paper finds.

However, “Do Retired Americans Annuitize Too Little? Trends in the Share of Annuitized Income” contends that many middle- and high-income aged families would experience a jump in monthly income if they annuitized their wealth.

Pension annuities offer retirees a simple vehicle for insuring themselves against the risk of outliving their retirement savings, the paper says. As the U.S. workplace retirement system shifts to defined contribution (DC) pensions with lump-sum payouts, it seems logical to think retirees will shift their retirement savings portfolios towards annuity products in order to replace the guaranteed life income payouts that were once provided by old fashioned, defined benefit (DB) pensions. Such a shift has yet to occur, however.

Only a very small percentage (8%) of older workers and recent retirees with DC-type lump-sum payouts has purchased or intends to purchase an annuity with their retirement savings. Economists and experts on insurance agree that annuities can play a key role in providing stable retirement income that lasts for the lifetime of retired workers and their spouses.

 Most families receive a substantial portion of income in some form of annuity

For the average family headed by a person 62 or older, two-thirds of total income consists of some form of annuitized income—Social Security, public or private employee pensions, or annuities. Aged families in the bottom two-fifths of income distribution report a higher percentage of annuity income compared with families in the top three-fifths of the distribution. In the higher ranks of the income distribution, annuitized income flows account for a progressively smaller percentage of total family income.

Many explanations have been offered for the very small share of retirees who buy annuities. One reason is that most retirees already receive a substantial fraction of retirement income in annuity-like payments. Another is that many Americans nearing retirement do not have enough financial assets to make it worthwhile to purchase an annuity.

The researchers consider the 62+ or aged population as a whole, as well as different parts of the aged families’ income distribution from the early 1980s through 2009, drawing on survey data from the March Current Population Survey and the Survey of Consumer Finances.

Family income consists of annuitized income flows (primarily Social Security and pensions) and is measured as a share of families’ total money income. The definition of both annuitized and non-annuitized income has been expanded to include income flows not captured in the surveys, namely, health insurance subsidies and the housing services received by homeowners. The paper also considers the potential impact on aged families if they were to convert their wealth into private annuities.

“Do Retired Americans Annuitize Too Little? Trends in the Share of Annuitized Income,” by Barry P. Bosworth, Gary Burtless, and Mattan Alalouf, all with The Brookings Institution, can be accessed here.