A Piece of the Annuitization Puzzle:
The Role of Plan Rules in Annuitization Decisions in DB and CB Plans

Abstract

In spite of the valuable longevity insurance annuities provide, actual annuitization rates of retiree wealth remain low. Previous studies investigating what economists term the “annuity puzzle” have focused on workplace pension plans because they offer a choice between an annuity and a lump-sum distribution. These studies found large variations in annuitization rates among employer-provided defined-benefit (DB) and cash-balance (CB) plans but did not provide a concise explanation. This article does provide an explanation—in particular, variations in plan rules can explain the variation in annuitization rates. The rates vary directly with the degree of restriction imposed on lump-sum distributions. Plans with no option for a lump-sum distribution have annuitization rates of close to 100%, whereas plans with no restrictions on lump-sum distributions have annuitization rates of between 20% and 40%. Given an unrestricted choice, only a minority of plan participants choose an annuity.

TOPICS: Retirement, pension funds