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

Fewer Choosing Annuities in TIAA Plan

Woman being carried by a dollarIn a 401(k) world, purchasing an annuity is one way to turn retirement savings into a reliable source of income. But annuities have never been popular.

Now, a new study finds they are losing appeal even among some employees who historically purchased annuities at much higher rates than the general public: members of the TIAA retirement savings plan – one of the nation’s largest. Until 1989, TIAA required that retirees convert their savings into annuities.

Even in 2000, one out of two participants putting money in TIAA would eventually take their first withdrawal in the form of one of the annuity options the plan offers to retirees.

But by 2017, this number had dropped to about one in five, according to an NBER study for the Retirement and Disability Research Consortium that followed some 260,000 employees with careers at universities, hospitals, and school systems.

The researchers identified two distinct groups in terms of their annuity activity.

The first group tended to have smaller account balances and started tapping annuities in their retirement plans prior to the age when retirees are subject to the IRS’s required minimum distribution (RMD), which was, at the time of the study, 70½. Over the period studied, annuity selections by the first group fell from 57 percent to 47 percent.

The second group – people who had larger balances and didn’t touch their retirement accounts until after the RMD kicked in – saw their annuitization rate plummet from 37 percent to just 6 percent of the participants. …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

The Cares Act

Field Work

Wisconsin Finds Owners of Lost Pensions

Some people lose old retirement accounts because they forget about them. Others don’t want the hassle required to retrieve small amounts. And workers who change jobs fairly often can leave a lot of small accounts in their wake.

As a result, millions of dollars of retirement wealth – in pensions, 401(k)s, IRAs, profit-sharing plans, and annuities – sit in state repositories of unclaimed property.

So how can workers and retirees be united with their long-lost money?

To answer this question, a new study contrasts what has happened to unclaimed retirement accounts in two states with vastly different approaches to handling them: Wisconsin and Massachusetts.

Wisconsin in 2015 began to use Social Security numbers to automatically match up and return misplaced retirement accounts to their owners. As long as the account has a Social Security number attached to it, the state can find a resident’s current contact information in Wisconsin’s taxpayer records.

Under this system, two-thirds of the accounts were returned in 2016 and 2017, the researchers found.

Over the same two years in Massachusetts, only 3.4 percent of unclaimed retirement accounts were returned to their owners. Massachusetts takes the same passive approach used in most states: individuals must initiate the process by locating an account in the state’s unclaimed property database and then retrieve it themselves.

The University of Wisconsin study also uncovered an explanation for why some people are motivated to track down accounts on their own. …Learn More

Art saying Now what?

On the Web

Recession Destabilizes Boomers’ Finances

The COVID-19 recession has changed everything.

This extreme disruption in our lives is always top of mind, which was reflected in our most widely read articles so far this year, based on the blog’s traffic.

Baby boomers, their retirement plans having been deeply affected by the Great Recession, are once again reassessing their finances. One popular article explained that the boomers who were in their early to late 50s during the previous recession lost about 3 percent of their total wealth at the time. This put their retirement planning at a distinct disadvantage compared with earlier generations in their 50s, whose wealth, rather than shrinking, grew 3 percent to 8 percent. The current recession is the second major setback in just over a decade.

Prior to the pandemic, readers liked articles about making careful retirement plans. Post-pandemic, the most popular article was about laid-off boomers desperate for income who may have to start their Social Security prematurely. The retirement benefits can be claimed as early as age 62, but doing so locks in the smallest possible monthly Social Security check – for life.

Even before Millennials were hit by the recession, they were already farther behind older generational groups when they were the same age. One article explained that the typical Millennial had just $12,000 in wealth. They are “the only generation to have fallen further behind” during the pre-pandemic recovery, the Federal Reserve said.

Here are a dozen of this blog’s most popular articles for the first half of 2020. They are grouped into three topics: COVID-19 and Your Finances, Retirement Planning, and Retirement Uncertainties.

COVID-19 and Your Finances:

Social Security Tapped More in Downturn

Lost Wealth Today vs the Great Recession

Boomers Facing Tough Financial DecisionsLearn More

Field Work

Arcane but Shrewd Retirement Solution?

Hyacinthe Rigaud’s portrait of King Louis XIV, courtesy of the Getty Open Content Program

Tontines might be a nifty idea for retirement income. Too bad they haven’t been legal here for a century.

Tontine is a fancy word for betting on how long you’ll live – in a good way. Here’s the concept in a nutshell: many people pool their money in return for guaranteed regular payouts for life, similar to an annuity.

The people who live to, say 90, will receive ever-increasing financial payoffs, because the number of participants in the pool will invariably shrink over time.  The catch is that the investors who die young won’t receive as much income as the men and women who live the longest – but they won’t need the money either.

A new study by the Center for Retirement Research (CRR) takes a close look at an idea that is tossed around among finance experts: modifying tontines to use them as a source of retirement income.

Some criticize them as a dubious investment, but they’ve stood the test of time. King Louis XIV of France was the first monarch to raise public funds using tontines, a 1650s creation of Italian financier Lorenzo Tonti. More than a century later, they caused financial hardship among middle-class investors, laying some of the groundwork for the French Revolution.

Tontines made it into American popular culture in the M*A*S*H* television show. Because Col. Potter was the last man standing among his World War I Army buddies, he got the only remaining bottle of brandy from a cache they’d found and drank while camped out in a French chateau. Tontines popped up again in an episode of The Simpsons: grandpa Abe Simpson and Mr. Burns fight over some valuable German paintings in a tontine their Army unit had created back in World War II.

Credit for the idea of a retirement tontine goes to a paper by two professors at York University in Toronto, Moshe A. Milevsky and Thomas S. Salisbury. In his new report, CRR researcher Gal Wettstein agrees that tontines might be a useful way to get regular retirement income – with modifications. …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