The Annuity Puzzle and the Role of Pension Plan Structure and Decision Framing
This article consists of descriptions of both an empirical study and a behavioral study conducted by the authors, Shlomo Benartzi, Alessandro Previtero, and Richard H. Thaler, as well as the results of these studies, which provide insight into the annuity puzzle. The annuity puzzle describes the distinction between economic theory, which suggests that purchasing annuities make individuals better off when they face the risk of outliving their assets; and economic data, which shows that relatively few retirees opt to receive their retirement benefit in the form of an annuity. The authors’ empirical study makes use of two distinct data sets to understand the low annuitization rate among retirees and the potential reasons for that low annuitization rate. To further understand the annuity puzzle, the authors’ behavioral study looks at the impact on the consumer’s decision whether to annuitize or how the decision to annuitize is described or framed.
In the empirical study, the authors analyzed two distinct data sets on the annuitization decision. The annuitization decision is retirees’ decision to receive their retirement benefit in the form of an annuity (retirement benefit in the form of a series of payments made at fixed intervals) instead of a lump-sum payment (retirement benefit in the form of a single payment). The first data set examined by the authors reported the annuitization decisions of IBM employees between the years 2000 and 2008, consisting of more than 18,000 annuitization decision records. The authors found that 88% of employees chose to receive their retirement benefit fully in the form of an annuity, 8% received the benefit in the form of a combination of a lump-sum payment and an annuity, and 5% received the benefit in the form of a lump-sum payment. Given that employees below the age of 65 were presented with an annuity option that enhanced the value by approximately 15%-20% to encourage early retirement, however, the authors decided to also look exclusively at the payout decisions of employees above the age of 65.