After outlining the benefits annuities can provide to retirees, a new research brief by the Boston College Center for Retirement Research highlights a proposal for ensuring that more retirees will reap those benefits: have your 401(k) shift a percentage of your balance into an annuity at retirement unless you specifically opt out of doing so.
That raises a number of serious questions, among them: Is it okay to “nudge” you into an annuity on the assumption you’re better off with one but might not invest in one on your own? Or is this unwarranted meddling that could push you into an investment you may not need?
I’ve long recommended that people in or nearing retirement should consider devoting some, but not all, of their savings to an annuity as part of their retirement income plan. Annuities aren’t for everyone, and certain ones can be mind-numblingly complex and laden with onerous fees. But others—and here I’m thinking mostly of immediate annuities and longevity annuities—do a good job of providing features you can’t find in traditional investments. Most notably, you can get guaranteed monthly payments that will last no matter how long you live, regardless of how the financial markets perform.
Research also shows that people who have annuity or pension income tend to be happier in retirement and are more likely to report that their standard of living improved after they retired.
So I was totally on board as the author of this research brief, economist Steven Sass, not only meticulously demonstrated the value retirees can get from putting a portion of their savings into an annuity—in this case, a longevity annuity, which might begin making payments at, say, age 75 or 85—but also explained why so many retirement savers fail to “annuitize” despite the advantages of doing so. For example, some are worried they’ll die soon after buying an annuity and thus will have laid out a lot of money for a small number of monthly payments. Others have a hard time assessing the value of an annuity because it involves comparing a lump sum of, say, $100,000, to a series of future payments, say, $525 a month. (To see how much a given sum will generate in monthly lifetime payments given your age and gender, check out this annuity payment calculator from Immediateannuities.com.)
But I began to have reservations when I came to the section of the brief that dealt with ways to get around those “behavioral impediments” and get more people into annuities. The proposal that gave me the most pause was making an annuity “the default distribution of a portion of the participant’s balance at retirement”—in other words, arranging things so that unless you stipulate otherwise, some percentage of your 401(k) balance would go into an annuity.
Academics who specialize in “behavioral finance” love defaults and other types of nudges because they can be an effective way of getting you to do something you may be reluctant to do (like buy an annuity) even though it may be in your best interests (ensuring you won’t run out of money in retirement).
But implicit in the idea of steering you to the “right” choice is the assumption that someone else knows better than you what’s right for you.
“I’d say those who would nudge people into an annuity—or into any financial decision, for that matter—can’t know if that’s in their specific individual interests, considering the myriad other financial goals they may have,” says Mark White, author of The Manipulation of Choice: Ethics and Libertarian Paternalism.
Indeed, even if annuitizing a portion of savings is a fine choice for many, or even most, people, it may not make sense for many others for a number of reasons. For example, a person may already have all the guaranteed income he needs from Social Security and a pension or want to leave a legacy or have health problems that could shorten life expectancy—or he may simply prefer to mange his entire nest egg on his own.
Of course, there is the opportunity to opt out of the default. But the effectiveness of that escape hatch depends a lot on how the default is structured. The less attention that’s called to the default or to your right to override it, the more people are likely to end up with the default option, even if it’s not the right choice for them.
Which is why Sass believes that in the case of annuitization
—a decision that can be pretty complex and that’s typically irreversible to boot—any default should come with some sort of education. “It’s important to make sure 401(k) participants know what’s going on,” says Sass. “There has to be some acknowledgment that they understand. You can’t just put people’s money into an annuity without their permission.”
Still, even a default that’s explained and discussed can be plenty persuasive. Indeed, to the extent choosing an annuity is presented in seminars or educational materials as “the smart thing to do,” the more people will be likely to go along with it—if for no other reason than that that choice effectively has the endorsement of an authority figure or expert.
I realize that many 401(k)s already have defaults, such as automatically enrolling new participants into the plan with their money going into a target-date fund or another pre-selected investment unless the employees overrule the default. And one can argue that the good these defaults do in getting people to save for retirement outweighs the fact that they achieve that end through subtle manipulation.
But it seems to me that a decision as momentous as putting a chunk of your life savings into an annuity—an investment that can be difficult to understand and that may be impossible to get out of—is one that you should fully understand and be actively engaged in. And you should make the move only if you believe it’s in your best interests, not because someone else does.
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Regardless of whether this proposal becomes a reality, the issues surrounding defaults and nudges are still relevant when it comes to retirement income and annuities. The reason is that people generally don’t just decide out of the blue to buy an annuity. More often, they’re nudged—in some cases, pushed may be a better word—into doing so by an adviser who stands to gain by selling the annuity.
Bottom line: For many people, devoting a portion of their 401(k) balance or other savings to an annuity can be an excellent way to insure that they don’t run short on income in retirement. But that doesn’t necessarily mean it’s the right choice for you. So if for whatever reason you’re thinking about making an annuity part of your retirement income strategy, take the time to understand how annuities work and learn what questions to ask so you can make a more informed decision. But most of all, don’t buy an annuity just because you’re being nudged to do so.
Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at [email protected]. You can tweet Walter at @RealDealRetire.