Higher Interest Rates, Longer Lifetimes, and the Demand for Life Annuities

Abstract

Life annuities are attractive retirement vehicles because (1) they provide annuitants with an income they cannot outlive and (2) historically the annual income has been substantially higher than the amount the annuitant could receive by investing a principal sum equal to the present value of the annuity and living on the investment income. If the rate of return that can be earned by investing the principal is the same as is assumed in the annuity income calculations, the annuity income will be higher for all survivors because the principal amounts contributed by all annuitants is amortized among those who survive. Of course, if the annuitant chooses not to select an annuity but to invest the lump sum and live only on the investment income, some heirs would receive a legacy. If the annuitant occasionally used any of the principal to supplement the invested income, future investment income would be reduced, assuming no offsetting increases in the investment rate of return. If the annuitant made frequent withdrawals from the principal and lived many years, the principal might be exhausted before the annuitant's death. Annuities are an attractive individual insurance product and a basic part of private pension plans. At year-end 1983 the number of individual annuities in force (not including supplementary contracts providing life income from life insurance proceeds) was 8.5 million, 57 percent more than at the close of 1980.' This growth has been attributed largely to the purchase of annuities to fund Individual Retirement Accounts authorized by the Employee Retirement Income Security Act of 1974 and expanded by the Economic Recovery Act of 1981. Another important stimulus, however, has been the popularity of single-premium deferred annuities as a tax-deferral device. At year-end 1983 over 32 million persons, 24 percent more than in 1980, were covered by

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