Dave can count on a traditional pension, paying $4,000 a month for the rest of his life. Ron, on the other hand, will receive its benefits to a lump sum that it must manage itself. Ron a lot of choices, but all have consequences. For example, he could put the money in a conservative bond portfolio and by drawing on the principal and the interest of the expenses that he might spend $4,000 per month. If Ron is the case, however, it can if expected to run out of money by the age of 85, including the actuarial tables say there's a 30 per cent chance of achieving. Or he could take down only $3,000 per month. It would be as much to live each month, but his money should last until it reaches 100.
That is likely to be happier now? Dave or Ron?
If this question seems obvious, welcome to the club. Almost everyone seems to prefer the certainty of the pension of Dave Ron complex options.
"" But that's the problem: even if people like Dave that they tend to love them, old-fashioned pension "defined benefit" are a breed endangered. On the other hand, people like Ron - with defined contribution as 401 (k) plans-can transform uncertainty into a guaranteed monthly income stream that reflects the earnings of a traditional pension plan. They may do so by purchasing an annuity - but when offered the chance, almost everyone refuses.
Economists call it the "annuity puzzle." Using standard assumptions, economists have found that buyers of annuities are insured more annual revenue for the rest of their lives, compared to people manage their portfolios. One of the reasons is that those who buy annuities and die at the start end up subsidizing those who die later.
Then, why not more than people buy annuities with their 401 $?
Here is part of the answer: some people think that buying an annuity is a bad deal for their heirs. But that is not true. First of all, a retired may decide to cancel part of a retirement nest egg for bequest, either immediately or at a later date. Second, if a retired to manage his own money, the heirs may face the following possibilities: either they get financially "lucky" and the parent died young, leaving a legacy, or they are financially "unfortunate," which means that the parent lives a long life, and the heirs take the load support. If you have aging parents, you may ask you how much you would be willing to pay to ensure that you never have to find a way to explain to your spouse, or anyone you can be reached, that your mother is moving in.
There are other explanations of the unpopularity of the pension, but I think that the two are particularly important. The first is just buying one can be scary and complicated. Workers are accustomed to having their employers to restrict their series of choices to a few manageable, either in their 401 plans or in their choice of providers of health and life insurance. However, very few 401 (k) offers a specific annuity option that was blessed by the Department of human resources of the company. Shopping for an annuity, with hundreds of thousands of dollars at stake can be difficult, even for an economist.
The second problem is more psychological. Rather visualize an annuity as providing insurance where one lives above 85 or 90, most of the people seem to consider buying an annuity as a bet, which was to live a certain number of years of profitability. But, as the example of Dave and Ron shows, is the decision to self-manage your wealth of retirement is risky.
The more complex and unpredictable risk predicting how long you will live. Even if there is no progress of the medicine in the years to come, according to the Social Security Administration, a man with respect now 65 has almost 20% chance of living to 90, and a woman of that age has almost a third chance. This means that a husband who withdrew when his wife is 65 should include in its plans a chance of a third party that his wife will live for 25 years. (An annuity "joint and survivor" who pays until both members of a couple of die is the only way I know that for those who are not rich with confidence this problem.)
An annuity can also help people with another important decision: when to retire. It is difficult to get an idea of how much money is enough to finance a lifestyle in retirement. But if a lump is translated into a monthly income, it is much easier to determine if you have enough set aside to afford to stop working. If you decide, for example, that you can get about 70% of pre-retirement income, you can simply continue to work until you have accumulated as the level of benefits.
IN the absence of annuities, there is reason to be concerned that many workers is the difficulty with this decision. Over the past 60 years, the Bureau of Labor Statistics reports that the average age at which Americans retire has trended downward by more than five years of 66.9 to 61.6. Of course, there is nothing wrong with choosing to withdraw a little earlier, but during the same period, life expectancy increased by four years and will likely continue to climb, which means that pensioners have to finance at least another nine years of retirement. Those who manage their own retirement assets can only hope that they have saved enough.
Rents some of these issues can make it easier to resolve, but few Americans actually choose to buy. If the cause is a perhaps rational fear of the viability of insurance companies, or false ideas about whether pensions increase rather that decrease the risk, the market has not understood how to sell these products successfully. Is there a role for Government? Listen next time for some thoughts on this issue.
Richard h. Thaler is a Professor of Economics and science of behaviour at the Booth School of Business, at the University of Chicago. He is also a school counsellor Allianz Global Investors Center for behavioural Finance, part of Allianz, which sells financial products, including annuities. The company has not consulted for this column.
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