How Can We Realize the Value That Annuities Offer in a 401(k) World?

Annuities have long been the basic building blocks of the U.S. retirement income system. Both Social Security and traditional employer pensions are annuities, paying retirees a specified sum each month for as long as they live. But due to the decline in Social Security replacement rates, for any given retirement age, and the shift in employer plans from defined benefit pensions to 401(k)s, a growing number of workers are entering retirement with more financial savings and less annuity income. Economists generally agree that many retirees would benefit if they annuitized at least some of their 401(k) savings. This brief reviews studies by the U.S. Social Security Administration’s Retirement Research Consortium that assess how best to meet this goal. The discussion proceeds as follows. The first section presents the value that annuities offer. The second section explains how this value is affected by medical expense risk and bequest motives. The third section identifies key behavioral impediments to annuitization. The fourth section reviews initiatives that address these impediments. The fifth section concludes that accustoming 401(k) participants to focus on retirement income rather than accumulations and developing an effective default distribution for 401(k) assets are promising initiatives to explore.