Two-thirds of US defined contribution (DC) plan participants say that a secure retirement income stream is the most important feature they’re looking for, as we noted in our seventh annual survey report. But US workers rarely convert their retirement savings to lifetime income by purchasing a traditional fixed annuity. What’s standing in the way?
The primary reasons behind this “annuitization puzzle” are behavioral. For example, most people are more worried about dying sooner than about dying later, so they discount the need to prepare for a long life. Family medical history and illness are common reasons why people assume they won’t live as long as they’re likely to. Concerns about the cost of healthcare also often trump the fear of outliving retirement savings.
In fact, many retirees–particularly men–misjudge their lifespans. Although the average life expectancy for a 65-year-old man in the US is more than 82 years, nearly two-thirds of male retirees think they won’t live past 80 (Display). Putting off planning for a secure income no matter how long you live is simply kicking the can down the road. It may lead to difficult decisions later in life, when retirees have fewer options.
Another significant hurdle is retirees’ desire to keep control of their retirement investments. To many people, the idea of “losing” their assets to an insurance company at death—assets that otherwise would have been passed on to their beneficiaries—is highly unappealing. Studies on loss aversion show that for most people, the pain of a financial loss is about twice as intense as the pleasure of a financial gain. Retirees seem particularly sensitive to this, according to one recent study.*
Looking beyond the behavioral aspects, there are sound financial reasons for retirees’ reluctance to annuitize and surrender control. I discussed many of these reasons in a recent blog post; they include the possible need to access savings to handle healthcare emergencies and the desire to maintain growth potential to combat inflation. Taking these financial reasons into consideration, along with behavioral impediments and concerns regarding cost and complexity, perhaps it isn’t so puzzling after all that so few US workers annuitize their retirement-plan savings.
Nonetheless, plan participants do want a steady income stream in retirement. And what’s more, the vast majority of surveyed participants cite a desire to know what level of retirement income they might have well before they retire. So what’s the solution?
Plan sponsors have made great strides over the past several years by adding automation features that help boost plan participation, increase savings and improve investments. These enhancements, while excellent and well received, are designed to help participants accumulate savings. But the ultimate goal of a retirement plan is to provide income. The clear next step, in our view, is to extend plan automation to help participants build both savings and lifetime income.
This type of solution can help overcome behavioral biases through automation, but it would also need to provide the simplicity, control and access to savings that participants value—and that traditional annuities lack. Moreover, the solution would need to benefit not only plan participants, but also the sponsoring organization and the other service providers to the plan, in order to prompt widespread adoption.
I’ll discuss what a solution like this might look like in my next blog posting.
*Eric Johnson, “Hyper Loss Aversion: Retirees Show Extremely High Sensitivity to Loss, but Shy Away from Guarantees That Require Giving Up Control,” based on an interview with Shlomo Benartzi for Allianz of America, in Behavioral Finance and the Post-Retirement Crisis, April 2010.
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Seth J. Masters is Chief Investment Officer for Defined Contribution Investments and Asset Allocation at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.