Lump Sums vs. Annuities: Different Effects on Saving Intentions
In the process of planning for retirement, pre-retirees can view their accumulated wealth as a lump sum (e.g., $100,000) or as the projected lifetime income that such a lump sum could buy as an annuity (e.g., $500 per month for life starting at age 68). In “The Illusion of Wealth and Its Reversal,” Daniel Goldstein, Hal E. Hershfield, and Shlomo Benartzi explore whether pre-retirees have different perceptions of retirement wealth that is presented as a lump sum versus wealth that is presented as equivalent monthly amounts. The authors were motivated by the US Department of Labor’s proposal that annual 401(k) statements display the projected lifetime income that the account will be able to buy in retirement. That proposal went into effect in 2021 as part of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.
Using three online surveys, the authors show that, at lower wealth levels, pre-retirees view lump sums as representing more wealth than monthly annuities; this effect, known as an illusion of wealth, reverses at higher wealth levels. As a result, the saving plans of pre-retirees were more sensitive to projected changes in wealth at retirement when that wealth was presented as a stream of monthly amounts than as lump sums, a finding with significant implications for the annuity puzzle and for Social Security benefit claiming decisions.