The Annuity Puzzle and Bequest Motives
This article focuses on the role of bequest motives (i.e., the desire to leave assets to family members, friends, or charitable causes) in explaining the annuity puzzle. The annuity puzzle refers to the divergence between economic theory, which suggests that annuities are better investments for individuals facing longevity risk (i.e., the risk of living longer than expected, and having insufficient funds to finance retirement needs), and the reality that relatively few retirees are opting to receive their retirement benefit in the form of an annuity (i.e., a retirement benefit in the form of a series of payments made at fixed intervals). In this article, Lee Lockwood uses survey data to simulate and estimate the demand for annuities, with the goal of trying to understand the role any desire to leave a bequest has on the demand for annuities. From the simulation, the author derives several insights surrounding factors that help explain demand for annuities, including bequest motives, medical spending risk, and minimum annuity purchase requirements. The insights derived from the author’s simulation help explain the low demand for annuities, despite their many benefits.
Those without bequest motives gain more from choosing to annuitize their wealth than do those with bequest motives. For retirees without bequest motives, the author finds that the largest component of the gain from annuitizing their wealth is being able to trade involuntarily leaving a bequest upon their death (because they did not have a chance to spend all of their wealth) for higher spending throughout their remaining lifetime. In contrast, those with bequest motives stand to gain less from annuitizing their wealth, since they can rely on leaving a smaller bequest rather than on purchasing an annuity for consumption smoothing.