The road to retirement is paved with complex decisions. Besides considering how much to save and how to allocate one's portfolio, prospective retirees, especially those whose retirement savings reside in defined-contribution plans such as a 401(k), face the consequences of exhausted funds. In other words, even a sizable nest egg from the most studious saver can run out of funds over time--especially if one lives a long life.
The insurance industry has long offered a product designed to prevent a retiree from running out of money: the annuity. Although annuities come in many shapes and sizes (immediate vs. deferred annuities and variable vs. fixed annuities, for example), their singularity is a stream of guaranteed income that the owner of the annuity receives from the insurance company during retirement.
Despite the advantages that annuities can offer to many prospective and current retirees, they remain relatively unpopular. We wondered whether some of the barriers to purchasing annuities are psychological. To pursue this curiosity, we conducted an experiment in which we manipulated the frame of this insurance product (that is, its label) and whether the problem that it's trying to solve--running out of money during retirement--is on one's mind.
The Annuities Experiment
A total of 1,067 American adults ages 30 and over, recruited via Prolific, participated in this study (the median age was 49). We manipulated the frame of the product by labeling it as either an "annuity" or a "guaranteed stream of income," per random assignment, in a set of questions assessing willingness to purchase the product, comfort with an employer purchasing the product using one's retirement funds, the portion of retirement savings one would be willing to exchange for the product, and preference for an immediate over a deferred product. As an example, the question we used to assess willingness to buy the product was:
I would exchange a portion of my 401(k) balance for [a guaranteed stream of income or an annuity] that starts at retirement and ends at death.
To manipulate the salience of depleted retirement funds, participants responded to two questions probing into their perceived prospects of running out of money during their retirement either before or after the frame manipulation. Participants also provided us information on their age and income level at the end of the study.
The results of this experiment offer us several insights into why some may (or may not) purchase annuities. Let's now dive into two of the primary findings and extract a few lessons from them.
The Major Discoveries
1) People are more willing to use some of their 401(k) to purchase a guaranteed income stream for life than for an annuity.
The frame condition yielded a direct effect on one variable: participants' willingness to exchange a portion of their retirement savings for the product. Specifically, we found that participants were more willing to use a portion of their retirement money to purchase a guaranteed stream of income rather than an annuity.
Although this effect was relatively small (accounting for approximately 1.8% of the variance in willingness to purchase the product), it shows us that a guaranteed income appeals to people. That is, labeling an annuity by its intended purpose, a guaranteed income stream, can give people incentive to purchase the product as part of their retirement preparation.
2) Thinking about running out of money during retirement increases preferences for deferred over immediate annuities.
Our sample generally desired immediate over deferred annuities. Approximately 78% of our participants preferred to pay $100,000 for lifelong cash payments immediately at retirement than to pay $29,000 for lifelong cash payments that begin at age 80. Still, participants who thought about the possibility of running out of money during retirement were 8.6% more likely to prefer a deferred annuity.
What this finding teaches us is that people tend to want cash now, and they are willing to offer a hefty lump sum for it. Yet, this preference for immediate payments may be grounded in shorter-term thinking, given that eliciting some longer-term planning (that is, all the way to age 80) shifts one's financial focus from the now to the later; people may be more willing to wait for money if their patience translates into security at a later age.