If
you have a decent-sized nest egg for retirement, or are on your way to amassing
one, your retirement worries are only half solved. You still have to figure out
how to make your money last as long as you do. That could be a complicated
process even if you knew how long you were going to live. The fact that you
don’t only adds uncertainty to complexity. Median
life expectancies are only rough gauges. At age 60, men are typically expected
to live to age 81 and women to 84. But there’s a good chance (about 30 percent)
of living five years longer than that, and a 10 percent chance of living 11
years longer. Individuals with higher earnings have significantly longer life
expectancies than those with lower earnings.
The
danger of outliving your money is called longevity risk. As the population
ages, coping with longevity risk has become a central concern of retirement
planning and public policy. Last year, the Treasury Department issued rules to
make it easier for people to use a portion of their 401(k)s or IRAs to buy
“longevity annuities.” Those are novel insurance contracts that promise a
stream of monthly income, generally for life, in exchange for an upfront
payment. But the monthly payments do not start right away. Rather, they begin
in five, 10 or more years from the time the annuity is purchased.
That
delay makes longevity annuities cheaper than other types of annuity contracts.
It also means you might die before the monthly payments ever begin, or shortly
thereafter. A new research
paper by the Center for Retirement Research at Boston College has
found that mere mortals have “cognitive constraints” when confronted with a decision
about whether to buy an annuity. The research looked at financial literacy,
numerical ability and education level. It takes a lot of all three to wrap your
head around whether an annuity is a good choice.
The
research grew out of the observation that even among people at risk of
outliving their money, few people buy annuities. Many plausible explanations
have been put forward for the lack of interest, including cost and regulatory
barriers. The
new paper, however, finds that annuities are too hard for many people to figure
out, a mismatch that leads people to make decisions in other ways — say, by
sticking with what they do understand or with the way things are, no matter how
suboptimal those options may seem from a cognitively unconstrained point of
view. A paper
released last year by the Brookings Institution found that people
who rely on advisors may be especially unlikely to buy longevity annuities. One
reason is that advisors who are compensated as a percentage of client assets
may be reluctant to recommend annuities because the upfront payment to buy them
will reduce the base on which the advisor’s pay is determined.
The
research from the Center for Retirement Research ends on a cautionary note,
warning that its findings indicate that “many individuals, on their own, are
unable to make good decisions about managing their money in retirement.” The
Brookings paper advocates for several reforms to make the market for longevity
annuities more robust, transparent and consumer friendly. Some of the reforms
address ways to attract customers, including a certification process to attest
to the financial health of the insurer offering the annuity. Other reforms
would ease the liability concerns of employers that offer annuities within
401(k)s. For now, the bottom line is that longevity risk is real, but there are
significant obstacles to overcome to help people cope with it.
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