Annuities’ Bad Rap

Research shows a link between a good comprehension of annuities and a more favorable view of the products; unfortunately, annuity know-how remains low among individual investors.

Art by Miriam Martincic


When Alison Salka considers questions about annuities for the polls LIMRA fields in her role as senior vice president and director of LIMRA Research, she anticipates some negative feedback.

“It’s been broadly acknowledged that annuities can be a loaded term,” she says.

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Retirement plan participants’ tendency to dislike annuities is well-documented. Yet at a time when workers approaching retirement appreciate the value of creating stable income to replace their paycheck, some see a paradoxical desire for the role annuities can play in a portfolio in general, even if some investors voice a disinterest in annuities in particular.

Salka, based in Windsor, Connecticut, ascribes some of these attitudes to more than just the psychology associated with the term “annuity.” The surveys LIMRA has conducted show a pattern linking a good comprehension of annuities with a more favorable view, she says. In one example, 40% of people who are knowledgeable about annuities said they would want to convert retirement assets into guaranteed lifetime income. This falls to 15% among those who are not knowledgeable, according to Salka. But those with an understanding of annuities tend to be a minority of investors. One study found just one in four consumers were able to correctly answer seven of 10 questions about annuities.

“Clearly consumers don’t know a lot about annuities. That matters, because we found that positive perceptions of annuities are associated with higher levels of knowledge,” Salka says. “So, as you understand more about annuities, you view them more positively and your interest in converting assets into guaranteed lifetime income goes up.”

Greg Adams, a consultant at Fiducient Advisors, also based in Windsor, blames some of the negative sentiment about annuities on those that had high costs or fees that were not well-understood.

“There was a point at which annuities were getting a bad rap, and I think it had a lot to do with some of the sales practices that were out there,” he says.

But annuities can serve a useful role for many investors, Adams says.

“The way I have looked at annuities is kind of like medication,” he explains. “The right medication for the right person is going to do wonders for them, whereas the wrong medication for the wrong person is going to be catastrophic.”

Finding a suitable annuity may require more research, either from an adviser or someone else acting in a fiduciary capacity. Trusted experts can help match investors with an annuity that best meets their needs, Adams says.

Problems with annuities arise when there are surprises or misunderstandings in the purchase process.

“You buy an annuity because of the protection, the safety and the guarantees,” Adams says. “You like the idea until you find out your all-in fees are over 2% a year, as opposed to an index fund where you could be paying a few basis points a year. When individuals are surprised by pricing or product features after the fact, it can seem like an annuity is a bad product, but there could actually be a ton of value that the individual was receiving.”

The Setting Every Community Up for Retirement Enhancement—aka SECURE—Act is also likely to usher in new annuity options in the defined contribution space, Adams says. Already, Adams is helping plan sponsors establish a prudent process for selecting income products and making sure that process is in accordance with the governing bodies and regulations.

“There’s still a lot of work that needs to be done before we’re going to see it in all of the qualified plans,” he says.

The biggest challenge is grasping what the regulatory bodies will look for to grant a safe harbor to plan sponsors, Adams says. Some of the questions Adams is helping to pose include: How do plan sponsors benchmark and compare? How do they potentially educate, or not educate, participants? What do they need to understand about the underlying organization that’s providing the product? And are they now going to evaluate insurance companies?

Part of the solution may lie in developing more descriptive language. Adams already sees greater use of the word “income” or “income-oriented” or “managed payout” funds, wherein some providers offer balanced funds that include a 5% allocation that will generate income for the participant.

“Most people can say, ‘Hey, I need x amount of income per month to pay my bills,’” Adams says. “So, if they can start saving and investing, contributing their money, contributing the employer match to something that’s guaranteeing them income in retirement, I think that’s a little bit more of an intuitive way for participants to save and invest.”

Salka’s research also shows further division among investor goals. Some individuals are very interested in guaranteed income, and some would rather roll the dice on the markets, she explains.

“We find that people are very interested in turning assets into guaranteed income, because it makes them feel more comfortable if they have that guarantee,” she says. “For those who say they don’t like them or don’t want them, those people tend to say it’s because they are going to lose control of the assets.”

In surveys probing interest in whether employers should offer a product with guaranteed income, Salka found that the majority of people wanted that as an option. When asked about the option to build guaranteed lifetime income by investing all or part of their contributions in an investment option with an additional cost as part of their retirement savings plan offered by their employer, 17% of participants said they were likely to use it, while 40% said they were somewhat likely and 21% said they weren’t.

Salka sees further differentiation among people’s attitudes between the ages of 50 and 75. In a survey, individuals were asked to identify their ideal retirement income features. They selected which of five of 10 features, ranging from “income is guaranteed for life” to “heirs or charities will receive money when I die,” were most important to them. Then they were asked to allocate 100 percentage points across five features with more points indicating greater significance. When analyzed together with a series of other questions, it revealed that people tend to fall into one of three categories of investor: guarantee-seekers, estate-builders and asset-protectors, Salka notes.

“Historically, plan sponsors and plan advisers have said, ‘Oh I’m worried about my fiduciary duty, my participants aren’t interested, these are complicated,’” Salka says. “But the SECURE Act is making it easier, and I think it will be interesting to see if you get more adoption that way—that’s the first step. And the second step is to just help people understand the value of guarantees.”

Underestimating Longevity Risk

Americans’ projections about their own life expectancy often miss the mark, which can create problems in retirement.

Art by Miriam Martincic


Life expectancy has been in the headlines lately—and the news is mixed.

According to the National Center for Health Statistics’ August report, Americans’ life expectancy at birth has been declining for the past two years. The U.S. life expectancy at birth for 2021, based on nearly final data, was 76.1 years, the lowest it has been since 1996. The report cites deaths from COVID-19 and increases in unintentional injury deaths, which were largely driven by drug overdose deaths, as the primary causes.

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But here’s the less distressing news: the life expectancy at birth number isn’t applicable to retirement investors. What matters for that group is, first, the actuarial life expectancy at an attained age, and second, the individual’s estimate of his or her life expectancy at that attained age.

Those numbers can differ significantly, however. Wenliang Hou, now with Fidelity Investments but previously with the Center for Retirement Research at Boston College, has researched retirees’ assessment of longevity risk, defined as the risk of living longer than expected and exhausting one’s resources. He cites the University of Michigan’s 2016 Health and Retirement Study, which asked individuals to estimate the probability that they would live to a specified age. The study found that both men and women respondents underestimated the actuarial values significantly.

The Society of Actuaries has found similar widespread underestimation. A comparison of 2011 survey respondents’ estimates of personal life expectancy with population life expectancy found that 54% of retirees thought they would not live as long as the average person of their age and gender. Only 31% cited a life expectancy that was longer than the population average.

“According to the Society of Actuaries, about 43% of retirees underestimate their own life expectancy by at least five years,” says Kate Beattie, senior retirement income strategist with Capital Group in Los Angeles. “We know that Americans are living longer than ever before, and everyone seems to know that except for investors.”

What Causes Underestimation?

There is no single, universally accepted cause for the underestimation problem. Research from Rawley Heimer at Boston College has found that the accuracy of estimations varies with age and flips from underestimation to overestimation as people grow older. People in their twenties, for instance, overestimate mortality risk due to concern over the chance of dying from events that are statistically rare. In contrast, older people—Heimer cites the example of a 78-year-old cohort—tend to overestimate how long they are likely to live.

Beattie cites the prevalence of the statistic concerning life expectancy from birth as a cause for underestimation. Even though that number is irrelevant for an adult, it can influence thinking. People also tend to use their parents’ and grandparents’ years of life for estimating their own, says Wade Pfau, professor of retirement income at the American College of Financial Services and author of “Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success.”

The age to which parents or grandparents lived becomes the person’s default estimate, even though it’s too small a sample from which to draw conclusions. Also, that approach overlooks the U.S. history, until COVID-19, of lengthening life expectancies. “In the United States, longevity’s been improving by about a year per decade for people in their sixties,” Pfau notes.

Why Underestimation Matters for Retirees

Beattie maintains that it is important to estimate the investor’s planning horizon reasonably accurately because a mismatch will influence retirement spending and lifestyle decisions. If investors plan for too long a life span, they likely will live more frugally than necessary. But if they underestimate life expectancy by too much, they risk depleting their funds prematurely, Beattie says.

Underestimation can lead to excessively conservative investment portfolio allocations, according to Matthew Eickman, national retirement practice leader with Qualified Plan Advisors. “They become focused on the shorter term, which leads them to be more conservative from an investment perspective,” Eickman explains.

The result, says Eickman, is a loss of purchasing power relative to inflation. “What we have seen is that as life expectancies have become longer, without more counseling, retirement investors have not proactively adjusted their sights to recognize they need that type of equity exposure over the long run,” he says.

An accurate estimate also helps investors clarify their retirement goals and match their lifestyles to those goals more appropriately. Pfau has been part of a research effort to create a retirement style analysis. This work has identified time-horizon lifestyle preferences among retirees that he labels front-loading and back-loading.

“An investor with a front-loading preference will want to enjoy their retirement while they are alive and healthy, even if that means making cuts later,” Pfau says.

Retirees with a back-loading preference will worry more about outliving their money, Pfau says: “I’m willing to make cuts today to make sure that I don’t have to do anything drastic in the future. And I’m really worried that if I live to 95 I won’t have any money left.”

Improving and Using Life Expectancy Estimates

Beattie and Pfau suggest using online life span calculators to get more accurate projections. The Social Security Administration’s calculator provides a point estimate of additional life expectancy based on attained age, but Beattie and Pfau prefer the Society of Actuaries’ Longevity Illustrator. In addition to considering age and gender, this site allows the user or a couple to enter data about retirement age, smoking history and a self-assessment of general health.

The Longevity Illustrator’s output includes both individual and joint longevity percentile estimates for every fifth year of age in retirement (70, 75, etc.) and a distribution of life expectancies. Pfau says the user’s preference for front-loading or back-loading determines which percentile to focus on. If investors are worried about outliving their money—a back-loading preference—they will look more at the 10th percentile, which will be an older age. Those with a front-loading preference, who want to spend more now, will look at the 25th percentile, a younger life expectancy, says Pfau.

For example, consider a nonsmoking husband and wife in average health who both retired this year when they reached age 65. The Longevity Illustrator’s forecast of their joint life expectancy at the 25th percentile gives them a 22-year joint planning horizon, to age 87. The 10th percentile gives them a 26-year joint planning horizon, to age 91.

Pfau cautions couples not to misunderstand the estimates. “Something people don’t always recognize is if you have a couple, their joint longevity is longer than a single person,” he explains. “It’s kind of obvious when you think about it, but people don’t necessarily always realize that the probability of one person from a couple living to an age is higher for them jointly than just one person by themselves.”

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