Understanding the Role of Annuities in Retirement Planning

Abstract

Abstract This chapter investigates the role of annuities in the financial-planning process, including both the normative judgment about what role annuities “should” play (as guided by economic theory), as well as empirical evidence about the role that they actually do play. It describes several working hypotheses about behavioral biases that may affect annuity demand. The economic literature presents a strong theoretical foundation for the normative conclusion that annuities ought to be of substantial value to retirees. Simulation work reveals that under a specific process for inflation, a moderately risk-averse consumer would find nominal annuities less attractive than inflation-indexed annuities. The Pension Protection Act took significant steps to encourage the use of default options in the accumulation phase of 401(k) plans. It is noted that the economics and psychology of the annuitization decision remain a very fruitful area for additional research.

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