Guaranteed Income for Life, Part 1: Can Contingent Deferred Annuities Become a $100B Industry?

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“Why don’t Americans buy more income annuities1?” is a question asked so frequently by academic economists that, within financial professional circles, it is known by a distinctive shorthand as “the annuity puzzle.”

Retirement researchers see that most Americans choose to underspend theoretically “safe” portfolio withdrawal rates in retirement, with most retirees expressing a strong preference towards living exclusively off portfolio income and dividends rather than risking depleting their principal. But in the current unstable economic environment, producing safe, reliable income over the course of an unknown retirement is a daunting goal for any financial professional. As a result, many Americans sub-optimize their retirement experience by spending less than they can afford. Economists often view single-premium immediate annuities (SPIAs) as a critical tool in providing a safe base of income for retirees, particularly for covering basic expenses such as food, shelter, healthcare, utilities, and transportation.

But few Americans feel comfortable buying SPIAs. Economists posit the following reasons for this discomfort:

1. Interest rates are at historic lows, keeping payments low, and leaving consumers thinking, “If I wait to buy, I can lock in higher payments later.” Unfortunately, that strategy has not proven effective over the last several decades of nearly continuous interest rate drops.

2. Because these contracts are annuitized, they can’t be rolled over into a new annuity after a surrender period, and some speculate that this impacts the desire of agents to promote these contracts.

3. Retirees fear the effects of inflation on buying power when a material portion of their portfolio is not invested in the market (SPIAs with COLAs have been available, but are rarely purchased).

4. Americans with smaller account balances already have a material “annuity” in the form of Social Security and are therefore already over-annuitized relative to the rest of their (usually underfunded) retirement portfolio.

5. Annuities have a reputation as being expensive, and consumers have been told by financial pundits to mistrust annuity representatives who put their compensation interests ahead of clients’ interests.