Putting the pension back in 401(k) plans: optimal versus default longevity income annuities

Most defined contribution pension plans pay benefits as lump sums, yet the US Treasury has recently encouraged firms to protect retirees from outliving their assets by converting a portion of their plan balances into lon
Most defined contribution pension plans pay benefits as lump sums, yet the US Treasury has recently encouraged firms to protect retirees from outliving their assets by converting a portion of their plan balances into longevity income annuities (LIA). These are deferred annuities which initiate payouts not later than age 85 and continue for life, and they provide an effective way to hedge systematic (individual) longevity risk for a relatively low price. Using a life cycle portfolio framework, we measure the welfare improvements from including LIAs in the menu of plan payout choices, accounting for mortality heterogeneity by education and sex. We find that introducing a longevity income annuity to the plan menu is attractive for most DC plan participants who optimally commit 8-15% of their plan balances at age 65 to a LIA that starts paying out at age 85. Optimal annuitization boosts welfare by 5-20% of average retirement plan accruals at age 66 (assuming average mortality rates), compared to not having access to the LIA. We also compare the optimal LIA allocation versus two default options that plan sponsors could implement. We conclude that an approach where a fixed fraction over a dollar threshold is invested in LIAs will be preferred by most to the status quo, while enhancing welfare for the majority of workers.
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Metadaten
Author:Vanya Horneff, Raimond Maurer, Olivia S. Mitchell
URN:urn:nbn:de:hebis:30:3-417026
URL:https://ssrn.com/abstract=2853430
Parent Title (English):SAFE working paper series ; No. 150
Series (Serial Number):SAFE working paper series (150)
Publisher:SAFE
Place of publication:Frankfurt am Main
Document Type:Working Paper
Language:English
Year of Completion:2016
Year of first Publication:2016
Publishing Institution:Universitätsbibliothek Johann Christian Senckenberg
Release Date:2016/10/20
Tag:dynamic portfolio choice; longevity risk; retirement income; variable annuity
Issue:September 29, 2016
Pagenumber:41
HeBIS PPN:390298433
Institutes:Wirtschaftswissenschaften
House of Finance (HoF)
Center for Financial Studies (CFS)
Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:330 Wirtschaft
JEL-Classification:D14 Personal Finance
D91 Intertemporal Consumer Choice; Life Cycle Models and Saving
G11 Portfolio Choice; Investment Decisions
G22 Insurance; Insurance Companies
Sammlungen:Universitätspublikationen
Licence (German):License Logo Veröffentlichungsvertrag für Publikationen

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