The Valid and Not-So-Valid Reasons for Rejecting Annuities

The “annuity puzzle” asks why more people don’t focus on longevity protection and purchase annuities. Those products are favored by economists and actuaries who study retirement planning, but not by the public. Those who attempt to explain the unpopularity of annuities often focus on a single issue, for example the aversion to large irreversible financial commitments.

But a host of impediments stand in the way of allocating funds to annuities. Some issues relate to brokers or advisors, and others involve their clients. Some are valid, but others are questionable and reflect irrational behavioral biases.

I’ll explain the contributing factors and discuss the challenges to overcome them.

Valid reasons

Annuities are not for every retiree, and we can come up with valid reasons to exclude a significant share of the U.S. population as candidates to purchase annuities:

Insufficient funds/liquidity needs – It’s not possible to purchase annuities or other financial products without any savings. Various reports estimate that 20% to more than 50%of Americans have minimal or no savings. And for those fortunate enough to have accumulated at least modest savings, such funds may be needed for expenses such as out-of-pocket medical costs. This 2013 study by Reichling and Smetters estimated that lack of wealth would reduce the potential annuity market by more than 50%.

Low income – this is related to insufficient funds, but, for those on low incomes, Social Security may provide sufficient guaranteed lifetime income without the need for additional annuitization.

Other forms of annuitization – Defined-benefit pensions, more common in government jobs, may provide sufficient annuitization, and there’s an even stronger case for those in jobs that provide both a DB pension and eligibility for Social Security.