Why can one group love a product the other apparently hates? To answer that in just one word, I would choose "perspective." Economists and clients come at the issue from entirely different viewpoints. Academics typically examine macroeconomic and social issues, while clients are more interested in the microeconomics of their households.
And yet a number of trends will likely make lifetime income annuities more attractive, economists say. The most obvious of these is longer life expectancies. A 2006 Congressional Research Service (CRS) report to Congress indicated that the life expectancy of a newborn in the United States in 1900 was 49.2 years. The 2003 newborn, by contrast, is expected to live to 77.5 years old on average. This significant increase is attributable to advances in nutrition, medicine, environmental sciences, workplace safety regulations and other factors.
There is great debate within the academic community about whether we will see such dramatic life-expectancy increases in the 21st century. The rate of increase slowed significantly in the latter half of the 20th century. According to Stephen Goss, the chief actuary of the Social Security Administration referenced in the CRS report, the emergence of AIDS and SARS shows how quickly new diseases and antibiotic-resistant microbes can rise. Goss also asserts that medical advances may not be affordable for the masses and that the population in the U.S. has a tremendous problem with obesity and inadequate exercise.
Nonetheless, most of the research by far points to longer life expectancies, and lifetime income annuities provide a high degree of certainty that some income will be available, regardless of a person's life span.
Economists also cite the trend of fewer defined benefit pension plans and more defined contribution plans. My grandfather worked for the Chicago Transit Authority his entire adult life. Before he died, he collected a steady pension check for nearly 30 years in his retirement. These days, it is harder to find either a lifetime employee or a defined benefit plan.
The trend away from defined benefit to defined contribution plans has been under way for 30 years, but the pace of the shift appears to have accelerated substantially in recent years. A study by the benefits consulting firm Towers Watson showed that a mere 13 companies in the 2011 Fortune 100 offered their new hires a traditional defined benefit plan in 2011, while 58 companies did in 2000. And while 72 of the Fortune 100 maintained a defined benefit plan in the year 2000, only 30 of the firms on the 2011 list keep one. These plans are even rarer among small businesses, where the majority of Americans work.
With the increasing amount of responsibility placed upon individual workers comes great concern about their lack of financial literacy. Most of our personal finance education comes piecemeal from friends, family and the school of hard knocks. Personal finance information is typically sprinkled onto more traditional academic topics. For instance, schools in my community teach compounding interest as a math problem, but ignore the implications on someone's personal finances.
Meanwhile, the financial world has become more complex, and will likely become more so. I recently received notice that my home owner's insurance premiums were increasing 27%. As I reviewed information from my agent about alternative policies, I was reminded of just how difficult it can be to sort through one's financial matters. I am a highly trained professional with more than 20 years' experience who is familiar with financial terminology, yet it took almost no time for the whole matter to induce a raging headache.
Study after study about the utilization of 401(k) plans show unequivocally that most Americans are not saving enough and not taking full advantage of matching funds offered by their employers. Over time, the likely effect of this will be a population of workers with relatively small nest eggs.
The studies also show that a significant number of workers make poor initial investment choices, and if they revisit those choices, they make poor subsequent decisions. That means poor results on top of the inadequate savings.
With a large segment of the population mismanaging small accumulations, people will likely rely more on the government or other societal support than they would if they had better-managed, larger accumulations.
In the eyes of many economists and sociologists, annuitizing retirement accumulations eliminates many of these concerns by offering a steady income to those who might otherwise not have one. Such a move would not completely eliminate a retiree's dependence on the government or private-sector support, of course, since citizens can still mismanage a steady income. But by and large, economists seem attracted to the trade-off.
Last year, the General Accounting Office turned heads when it released a study that said only about 6% of 401(k) participants take a lifetime income payment option-and that more people should consider doing it for some portion of their retirement assets.
People receiving a secure annuity check cannot outlive their income. They do not have to make decisions about where to invest their funds, nor do they need to make subsequent decisions about how to adjust these choices. Their decision-making has been greatly simplified. They need only make decisions about how to spend the income.
Contrast that experience with the enormous complexities involved in managing a retirement portfolio. Retirees are supposed to learn from the media where they can find higher-yielding investments, how they can position their retirement assets, how they can manage income taxes on a nest egg, and what their safe initial withdrawal rate may or may not be.
Retirees also have to figure out how to incorporate their values and psychological traits into their plans. As I mentioned in a previous column, a budding community of academics and practitioners are examining what it takes to have a successful retirement in non-financial terms, including happiness, relevance and contentment.
The proliferation of blogs and social media has added to the volume of information. But not all this information is good or useful, and it can add to both clients' and advisors' confusion. A steady secure annuity check minimizes, if not eliminates, much of the complexity, anxiety and potential for error a retiree would face if he or she managed a lump sum.
Research seems to support this idea. Work by Bender (2004) and Panis (2003) finds that retirees are happier with a defined benefit pension than they are with a comparable amount of wealth in a retirement account.
Yet few clients buy annuities. Why?
I'll address several reasons in my next column, but before I end this one I'll mention one of the more popular scapegoats. Clients often say they eschew annuities because of the compensation financial advisors, consultants and planners receive for these products. There are some unethical people who don't do the best thing for their clients, but I'm skeptical that this ought to be as big a factor in the decision as it is.
Advisors, meanwhile, supposedly will not recommend annuitization because they will no longer have a lump sum to base their fees on or generate future commissions. But most advisors I know don't recommend against actions that could reduce the money they end up managing, such as paying off high-interest debt, gifting to family or making charitable contributions.
The lack of availability to funds affects clients far more profoundly than it does advisors. I'll have much more to say about this lack of availability next month, as it is one of many reasons clients reject these products.
Dan Moisand, CFP, is one of America's top independent financial advisors. He has spoken to advisor groups on five continents on topics such as managing investments and navigating tax complexities for retirees; retirement readiness; and most topics relating to the development of the financial planning profession. He practices in Melbourne, Fla. You can reach him at [email protected].