Research

Annuities: Useful but Little Understood

What makes a man tick

The general public is very cool on annuities. But many economists like the idea of retirees using some portion of their savings to buy them.

Annuities, with their fixed monthly payments, may be the best way to ensure retirees’ savings last just as long as they do. Otherwise, they may either spend it too fast and deplete their savings prematurely or spend too conservatively, depriving themselves of necessities in their old age.

New research suggests that one reason retirees don’t buy annuities is because they have great difficulty figuring out what they’re worth. When they try to figure this out, they bump up against their own cognitive limitations – limitations that only worsen with age.

In the study, 2,210 adults over age 18 were asked to estimate the value of a monthly annuity familiar to most workers: Social Security benefits. First, the research subjects were asked if they would pay $20,000 to “buy” a $100 increase in their monthly Social Security benefits. If the person said no, the survey repeated the question with a lower amount, eventually zeroing in on what this additional $100 benefit was worth to them. Next, the research subjects were asked to reduce – or “sell” – their monthly benefits by $100 in return for a specific dollar amount paid to them upfront.

In theory, the buy and sell prices they finally arrived at should be equal. But there was an enormous gap between the two. The median price research subjects were willing to pay was $3,000, and the median price at which they would sell was $13,750. There was also a wide range of sales prices among the individual participants: some would accept $1,500 or less, while others wanted $200,000 or more. …Learn More

Behavior

Annuities Have Real Value

Woman falling on money parachute

The value that annuities can provide to retirees may not be obvious, but it is real.

Annuities are also becoming increasingly valuable as fewer people have that traditional source of reliable retirement income: an employer pension.

Insurance company annuities, like pensions, pay out a monthly income no matter how long you live. These payments come from three sources: 1) the initial amount invested to purchase the policy; 2) the interest earned on the amount that’s invested before it is paid out; and 3) “mortality credits.”

These mortality credits are the essential element that protects retirees from outliving their savings.  As a retiree moves through her 80s, a growing share of the other people in the annuity pool die.  The funds they leave behind in the pool are used to continue making monthly payments to those who are still living.

This is the starting point for a new summary of academic research on annuities by the Center for Retirement Research at Boston College, which supports this blog. To fully understand the individual studies, it’s necessary to read the report.   But here are some takeaways: …Learn More

On the Web

Online Calculator Takes On Annuities

Not all financial calculators are created equal.

That’s what Fidelity Investments hopes baby boomers will conclude about its “Income Strategy Evaluator,” which may be the first online calculator that proposes how individuals should invest their nest egg to ensure it will last through retirement.

There are numerous calculators online to help working individuals tally how much money they will need to accumulate for their retirement, including “Target Your Retirement,” which was created by Boston College’s Financial Security Project, this blog’s host.

But the strategy for withdrawing from that nest egg during retirement “is very different than the accumulation discussion,” said Chris McDermott, Fidelity’s senior vice president of financial planning. That discussion requires individuals to answer the questions, “What do you want and how much can you get out of your assets?” …Learn More

top 10 Illustration

On the Web

Readers’ Picks in 2015

Squared Away readers should know this ritual by now. We consult Google Analytics to determine the articles with the most reader traffic over the past year.

This blog covers everything from student loans to helping low-income people improve their lot. But this year’s Top 10 was dominated by one topic: retirement.

Readers’ favorites are listed in order of their popularity, with links to each individual blog:

  • Navigating Retirement Taxes
  • Medicare Primer: Advantage or Medigap?
  • Why I Dropped My Financial Adviser
  • The Future of Retirement is Now
  • Annuities: Useful but Little Understood
  • Winging it in Retirement?
  • Fewer Need Long-Term Care
  • Misconceptions about Social Security
  • Late Career Job Changes Reduce Stress
  • Mortgage Payoff: Freedom versus the Math

To stay current on our Squared Away blog in 2016, we invite you to join our free email list. You’ll receive just one email each week – with links to the two new posts for that week – when you sign up here.      Learn More