Working Paper: NBER ID: w22717
Authors: Vanya Horneff; Raimond Maurer; Olivia S. Mitchell
Abstract: Most defined contribution pension plans pay benefits as lump sums, yet the US Treasury has recently encouraged firms to protect retirees from outliving their assets by converting a portion of their plan balances into longevity income annuities (LIA). These are deferred annuities which initiate payouts not later than age 85 and continue for life, and they provide an effective way to hedge systematic (individual) longevity risk for a relatively low price. Using a life cycle portfolio framework, we measure the welfare improvements from including LIAs in the menu of plan payout choices, accounting for mortality heterogeneity by education and sex. We find that introducing a longevity income annuity to the plan menu is attractive for most DC plan participants who optimally commit 8-15% of their plan balances at age 65 to a LIA that starts paying out at age 85. Optimal annuitization boosts welfare by 5-20% of average retirement plan accruals at age 66 (assuming average mortality rates), compared to not having access to the LIA. We also compare the optimal LIA allocation versus two default options that plan sponsors could implement. We conclude that an approach where a fixed fraction over a dollar threshold is invested in LIAs will be preferred by most to the status quo, while enhancing welfare for the majority of workers.
Keywords: longevity income annuities; 401k plans; welfare improvements; retirement security; default options
JEL Codes: D14; D91; G11; G22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Introducing longevity income annuities (LIAs) (G52) | Significant welfare improvements for retirees (H55) |
| Optimal allocation of retirement assets to LIAs (G51) | Welfare increase (I38) |
| Defaulting participants into LIAs (G33) | Minimal reduction in retiree welfare (H55) |
| Higher mortality rates among less educated individuals (I14) | Lower welfare gains from LIAs (D69) |
| Well-designed default solution for LIAs (Y20) | Positive welfare effects for DC plan participants (H55) |