Do You Want a Private Pension Plan

Immediate annuities solve the problem most people say is their biggest fear: outliving their money. Buy an inflation-adjusted immediate annuity and you ensure the lifetime stream of income retains its purchasing power for the rest of your life. Yet, sales of immediate annuities are low among those who are in the age group of likely buyers. It’s a question that puzzles many in financial services, especially firms that sell annuities.Some possible explanations:

• Annuities are too complicated. But immediate annuities are fairly simple, and even after they are fully explained many people don’t buy.
• There’s a conflict of goals. People don’t want to run out of money, but they also want to leave something behind for loved ones or charity.
• People don’t want to give up control of their life savings. Insurers respond to this by adding provisions allowing access to part of the invested money. But these complicate the annuities and add to the cost of an annuity.
• Possible lost opportunities are another reason. People don’t want to give up the opportunity to earn more money when the next bull market comes around. That’s also a sign of overconfidence among investors. They believe they’ll be able to identify the next bull market early and invest in it.

I suspect there are two other reasons people are avoiding annuities. One reason is that current interest rates are low. There are people who say they’ll buy immediate annuities when rates are back to their long-term averages or some other reasonable level. Another reason supported by research of economists and psychologists is the choice isn’t presented the right way. Research indicates that when people are offered an annuity, even after a full explanation few are interested. But when they are offered a “private pension plan” and given the same explanation, a much higher percentage go for it. Another bit of research shows that people’s choices depend on what markets did the previous six months. If markets were down, people opted for annuities. When markets were up, people avoided annuities.

For most people the best bet is to diversify their retirement income choices. Combine Social Security with a diversified portfolio that includes growth and income components. Add immediate annuities as part of your portfolio. It’s better to buy annuities later, because the older you are the higher the income payments will be.