Mortality salience: why retirees tend to choose lump sums

[Walt34]

If you are being encouraged or even just "offered the opportunity" to switch to a different plan, there's usually a reason. And it's not to place money in your wallet...

Yes, when the County sent us all to a half-day seminar - on the clock - that was a strong clue that going for the new plan was probably not in my best interest.

 

[laurence]

I briefly read the study - it's very rigorous - they took over 700 observations from actual plan participants

Bottom line - it's a HUGE deal for most retirees, maybe not most on this forum but most retirees in general

I think the "anxieties" can be broken down into the three L's - lifestyle, longevity and liquidity - problem is, most DC (and to an extent defined benefit) plans don't offer payout options that can alleviate those anxieties:

Lifestyle - fixed annuity that covers basic expenses.
Longevity - QLAC or similar
Liquidity - hunk of cash left in the DC plan to leave to progeny or cover catastrophic expenses

anyway, this is the very first article I've ever read (and I've read tomes) that addresses the psychology behind annuity versus lump sum. all others just focus on the financial side and most are blog posts written by armchair actuaries

taking a lifetime annuity benefit in a single lump sum is a huge coin flip - you have a 50% chance to outlive it - also, taking lump sum distributions is known to cause poverty among the elderly but that's another scholarly article/discussion

so you get guaranteed income for life or....a coin flip that gives you a mansion and prime rib every night or a tent by the river with cat food every night

so how do we fix this? different plan designs and pre-retirement counseling, IMO

Prime rib or cat food? https://en.wikipedia.org/wiki/Fear,_uncertainty_and_doubt

Your ending reads like the last page of an annuity brochure. The risk of mortality should make people lean towards a lump sum, because if you do die early the annuity was a bad deal...and never mind the higher administrative expenses etc. There is a reason annuity salesmen exist, that fat commission came out of your portfolio.

 

[Big_Hitter]

Prime rib or cat food? https://en.wikipedia.org/wiki/Fear,_uncertainty_and_doubt

Your ending reads like the last page of an annuity brochure. The risk of mortality should make people lean towards a lump sum, because if you do die early the annuity was a bad deal...and never mind the higher administrative expenses etc. There is a reason annuity salesmen exist, that fat commission came out of your portfolio.

nope, not an annuity salesman, not even close

the ending has to do with "in-plan" (i.e. not retail) annuity options - those usually don't have commissions, if so, they are extremely modest

I don't manage assets or sell anything, except myself. What I'm (simply) attempting to advocate, is that plan sponsors allow more choices other than a single lump sum distribution out of a DC plan and provide rank and file employees some pre-retirement education. Single sum distributions are positively correlated with poverty among the aged, especially women. (this is not sexist)

Actually, the risk of longevity (related to mortality) would steer you towards an annuity, not a lump sum.

What's worse, outliving your assets or not outliving your assets - I'd say the former. Ask DW what her biggest fear is - being a bag lady.

It's easy to lose that lump sum...the annuity is certain.

 

[Big_Hitter]

Since annuities are largely mortality driven.... what actuaries do when they have a lump sum/annuity decision would have greater weight with me than what economists recommend or do.

what do actuaries know about anything




If I had the option, I'd take the a mix of the three Ls I outlined in post 1

 

[laurence]

nope, not an annuity salesman, not even close

the ending has to do with "in-plan" (i.e. not retail) annuity options - those usually don't have commissions, if so, they are extremely modest

I don't manage assets or sell anything, except myself. What I'm (simply) attempting to advocate, is that plan sponsors allow more choices other than a single lump sum distribution out of a DC plan and provide rank and file employees some pre-retirement education. Single sum distributions are positively correlated with poverty among the aged, especially women. (this is not sexist)

Actually, the risk of longevity (related to mortality) would steer you towards an annuity, not a lump sum.

What's worse, outliving your assets or not outliving your assets - I'd say the former. Ask DW what her biggest fear is - being a bag lady.

It's easy to lose that lump sum...the annuity is certain.

I saw nothing in your article about COLA or inflation....annuities feel good in year 1, not so great in year 15 when it will only buy you...cat food....

 

[rdy2go]

The first paragraph in the article reminded me of what they teach life insurance/annuity sales people in pushing people to make a buying decision - "back up the hearse and let them smell the roses".

 

[pb4uski]

....Contrary to popular belief, I am neither a jack-booted Nazi thug, nor a heartless person who has never known someone who lived off of SS alone.

Dang!!! I had just bet the house on jack-booted Nazi thug! Oh well..... back to work.

 

[Cobra9777]

...the annuity puzzle, the low rate at which retirees buy annuities even though economists recommend annuities as an optimal decision"

...the citation is in the pdf of the study

I clicked through the citation to find a 158-page paper from the Journal of Economic Perspectives. I read the first 10 pages or so before losing interest. From what I read, the argument seemed to be: (a) people are living longer, and (b) withdrawal rates are hard and thus most people will screw it up. It also requires that you ignore a bequest motive. Didn't strike me as particularly compelling, but again, I only read a small portion of the paper.

I had the same reaction to your post as pb4uski and HadEnuff... I see nothing universally auspicious about the annuity option just because 3 economists got together and wrote a paper. If there's some universal truth in the remaining 148 pages, maybe you could enlighten us? It is your thread after all. And the whole argument is predicated on the assumption that annuitization is an economic no-brainer.

 

[RobbieB]

I agree. I think annuities basically suck. But, they do have a "regularity" about them and you know geezers like to be regular -

I plan to use 10% of my net worth to buy an annuity about the same time I sign up for SS at FRA.

So, voting with my dollars, 10% annuity, 90% lump.

 

[Animorph]

I agree. I think annuities basically suck. But, they do have a "regularity" about them and you know geezers like to be regular -

I plan to use 10% of my net worth to buy an annuity about the same time I sign up for SS at FRA.

So, voting with my dollars, 10% annuity, 90% lump.

Can you buy a better SS annuity by waiting until age 70 before claiming? SS is generally better than commercial annuities, and COLA'd.

 

[RobbieB]

I have to wait until 66+ and I'm collecting on deceased wife's account now.

My plan is to Roth half the IRA over that time and buy the annuity with the IRA remains.

Easy tax planning, and no minimums to remember.

 

[Big_Hitter]

I saw nothing in your article about COLA or inflation....annuities feel good in year 1, not so great in year 15 when it will only buy you...cat food....

of course the annuities could be cola'd - should be relatively inexpensive too given the low future consensus on inflation

since you are so knowledgeable about this where did you study actuarial science and/or qualified plan design?

 

[Big_Hitter]

I clicked through the citation to find a 158-page paper from the Journal of Economic Perspectives. I read the first 10 pages or so before losing interest. From what I read, the argument seemed to be: (a) people are living longer, and (b) withdrawal rates are hard and thus most people will screw it up. It also requires that you ignore a bequest motive. Didn't strike me as particularly compelling, but again, I only read a small portion of the paper.

I had the same reaction to your post as pb4uski and HadEnuff... I see nothing universally auspicious about the annuity option just because 3 economists got together and wrote a paper. If there's some universal truth in the remaining 148 pages, maybe you could enlighten us? It is your thread after all. And the whole argument is predicated on the assumption that annuitization is an economic no-brainer.

yeah I'll work on it. just got off the golf course, my back hurts and I need a cold one

basically it has to do with uncertainty and risk pooling

 

[Big_Hitter]

The first paragraph in the article reminded me of what they teach life insurance/annuity sales people in pushing people to make a buying decision - "back up the hearse and let them smell the roses".

that's interesting since annuities are the inverse of life insurance. why would they teach the sales people the same techniques?

 

[RobbieB]

Please do and submit your synopsis. I ain't gonna read that manuscript either.

Pulp fiction is more my taste -

 

[Big_Hitter]

Please do and submit your synopsis. I ain't gonna read that manuscript either.

Pulp fiction is more my taste -

you guys want cliffs notes? geez

 

[RobbieB]

Rough time eh?

You should know better than to promote annuities here, it's just like suggesting the employment of financial advisors -

 

[Big_Hitter]

Rough time eh?

You should know better than to promote annuities here, it's just like suggesting the employment of financial advisors -

I'm just suggesting they be added as a distribution option to DC plans so you and I don't have to bail everyone out in 15 years. it's just an optional layer of protection

otherwise, in a dc-only world we will have a nation of destitute retirees

 

[pb4uski]

Can't just about anyone with a DC plan either buy and annuity or roll their DC balance into an IRA and buy an annuity? From what I know they effectively already have that option.

From what I can tell you like annuities and are probably disappointed that so few people utilize that option where they have it or decide not to buy annuities. That's fine, and there are some people who would prefer to require some annuitization to prevent people from being stupid... I don't agree but respect their right to an opinion.

 

[Big_Hitter]

Can't just about anyone with a DC plan either buy and annuity or roll their DC balance into an IRA and buy an annuity? From what I know they effectively already have that option.

From what I can tell you like annuities and are probably disappointed that so few people utilize that option where they have it or decide not to buy annuities. That's fine, and there are some people who would prefer to require some annuitization to prevent people from being stupid... I don't agree but respect their right to an opinion.

they can but they pay retail for it (sales loads etc.). in-plan options would be more cost effective. problem is they rarely exist.

 

[alaska55]

Some people need to look outside their own little world, not everybody has a government pension and SS which are both cola. I have SS and a very small non cola pension at 65 and am likely going to buy a spia annuity with about 15% of my IRA. Then about every 7-10 years reevaluate my finances and buy another small spia if needed for inflation. I'm right on the edge of having enough or running out if thing go bad in the market. I don't think I will have to eat cat food, but hamburger instead of T-bone is okay. The only people who shouldn't think about a annuity are the ones who have cola pensions and more than they could ever hope to spend. The next time we have 2008-09 market what happens if the market doesn't recover like the last 7 years.

 

[pb4uski]

Whenever those various lump sum or annuity threads pop up I am always thankful that my former employer's DB plan did not offer a lump sum so I didn't have that decision to make. So today I receive a mailing from them that they will be offering a "lump sum window" in August to October.

They will be sending me details later but I fully expect that it will be a raw deal so I won't take the lump sum, but only time will tell.

 

[Cobra9777]

yeah I'll work on it. just got off the golf course, my back hurts and I need a cold one

basically it has to do with uncertainty and risk pooling

Ah, I remember this thread... Big_Hitter has some homework.

 

[Just_Steve]

Whenever those various lump sum or annuity threads pop up I am always thankful that my former employer's DB plan did not offer a lump sum so I didn't have that decision to make. So today I receive a mailing from them that they will be offering a "lump sum window" in August to October.

They will be sending me details later but I fully expect that it will be a raw deal so I won't take the lump sum, but only time will tell.

I'm also thankful I wasn't offered a lump sum and if they sent an offer now I might throw it into the shredder without even looking at it.

 

[Independent]

From a public policy perspective, I have to agree with BH. I think it would be good if DC plans routinely offered an annuity option.

I think it would be even better if active workers got annual reports that provided their current balance, and the monthly income the current balance would buy if it could be used for a "standard" annuity today.

For some people, "annuity" is a scary word that sounds complicated (and, most of us will agree that some private sector variable annuities are both complicated and scary). Seeing it mentioned might get people over that hump so they can think about their choices.

One reason I'd like to do this is that I think it's easy to look at lump sums and unrealistically think I'm ready to retire. Looking at monthly incomes is sobering.