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Focus on Guaranteed Lifetime Income in Retirement Planning

On paper, annuities have everything that retirement savers need to meet their income needs when they are no longer working. But most workers are not choosing annuities because they aren’t aware of their value. There are other behavioral factors keeping people away from annuities as well. In the LifeHealthPro article “Why aren’t retirement savers choosing annuities?“, Marlene Y. Satter summarized some of the latest findings on this topic. The Center for Retirement Research at Boston College looked at the value of annuity products in relation to the increased risk of medical care and the desire to leave money to heirs upon death. One of the biggest questions they wanted answered was why workers don’t annuitize to create a guaranteed lifetime income stream and how these innate behaviors could be changed so that more people at least consider an annuity product.

Perhaps the biggest change that has happened to American workers over the past generation or so has been the shift from traditional pensions to defined contribution plans like 401k’s. Workers save in these defined contribution plans then are often left to their own devices upon retirement with this large chunk of money that they don’t know how to manage. Pensions pay you monthly income until your death, but you have to create an income stream from your 401k plan. You can guarantee lifetime monthly income by annuitizing a portion of your 401k savings. Declining replacement rates for Social Security are another factor taking away from the amount of annuitized income that Americans can depend upon in retirement.

When you buy an annuity, your payments are based on your life expectancy. Insurance companies use mortality credits to pool together the money of many different people in order to guarantee lifetime income to everyone. Inevitably, not everyone will live to their 90’s, so the money of those who die will finance the payments of those who live. This is insurance to protect everyone from running out of money while they are still living. Mortality credits also give you the opportunity to have higher income payments from your annuity than you would get from drawing down your savings. Another downside of the drawdown method is that you have no guarantees against outliving your money.

There are many benefits to using annuities in your retirement planning. Even so, the vast majority of retirees do not have an annuity product in their plan to guarantee lifetime income. You might not need an annuity if you have a company pension or significant wealth. But the majority of people could benefit from the guaranteed income provided by annuities. Many of the factors keeping people away from annuities are behavioral and are perceived drawbacks rather than truths. They are worried about complexity, how the options are presented and most of all, if they will lose out in the case that they are one of the people who die before receiving all of their income payments back. In order to change behavior, the system must adapt to changing conditions. 401k plan sponsors and employers should urge participants to focus on future income instead of accumulating a large sum of money. Some experts believe in a default option in 401k plans that will automatically transfer some of the savings into an annuity to provide lifetime income. There are significant behavioral barriers keeping people from choosing the guaranteed lifetime income that annuity products can provide.

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