Mercer Report Highlights the “Annuity Dilemma”

Many employees are hesitant to purchase an annuity, despite their desire for retirement income; however, some of these fears may be well-founded, Mercer says.  

Given the choice between a lump sum distribution and receiving monthly payments for life, most retirees would still opt for a lump sum, according to a recent Mercer report, “Retirement, Risk & Finance Perspective.” In a January 2011 survey, the Society of Actuaries found that only 20% of Americans aged 45 to 70 intend to purchase an annuity or other form of guaranteed lifetime income to protect their assets.   

The report outlines three behavioral finance attitudes that may be causing this hesitancy.

1) Fear of leaving money on the table:

  • A premature death could result in monthly payments that, in total, are less than the account balance used to purchase the annuity.
  • A locked-in annuity payment may result in a missed opportunity if the account balance had been maintained during a period of rising markets.

2) Overlooking the risks of volatile markets:

  • Retirees are overconfident in the ability of advisers – or themselves – to manage their investments.
  • Potential outcomes may be framed in such a way as to stress the prospect of increased wealth rather than the risk of investment losses.

3) Fixation on the large account balance:

  • Monthly annuity payments may seem undervalued in comparison.
  • Account balances seem like they will always generate more retirement income.
  • Retirees hope that markets will rebound to make up past losses.

However, the report also suggests that these fears may be justifiable for some employees, because of timing issues. The question posed was whether accumulated assets can purchase an annuity that would provide adequate retirement income for the individual’s lifetime.  The age at which the individual started saving for retirement may be the deciding factor, the report notes.

The authors created a scenario for two retirees aged 65: one who started saving at age 30, and the other started saving at age 35. Each employee contributed the same percentage of pay during the savings period and received employer contributions. The analysis found that for someone who began saving for retirement at age 30, purchasing an annuity will extend their retirement income for 12 years. Conversely, for someone who didn’t start saving until age 35, purchasing an annuity can shorten the timeframe for their savings to last.

The complete report is available here.