What Is the Value of Annuities?

The first cohorts reliant on defined contribution pensions are now entering retirement, leading to a new challenge: how to balance current needs against the risk of outliving oneÕs assets? Annuities, which offer guaranteed lifetime income, are a leading solution to this problem. However, take-up of annuities is low, with their expected cost cited as a main explanation. This brief, based on a recent paper, explores trends in the value of retail annuities. This topic has not been addressed in two decades, a period during which interest rates have declined, life expectancy has increased, and new annuity products have emerged. The brief looks first at ÒmoneyÕs worthÓ Ð the ratio of expected lifetime benefits to cost Ð and then at Òwealth equivalenceÓ Ð a measure that takes into account the insurance value of annuities. It also explores how both measures vary by socioeconomic status (SES). The discussion proceeds as follows. The first section describes the data and methodology for calculating moneyÕs worth and wealth equivalence. The second section explores trends in these measures for three types of annuities Ð immediate, indexed, and deferred Ð for the full population. The third section provides the current moneyÕs worth and wealth equivalence of immediate annuities for different SES groups. The final section concludes that moneyÕs worth has remained stable over time, with an expected payout of about 80 cents per premium dollar for immediate and indexed annuities and about 50 cents per dollar for deferred annuities. But, accounting for the insurance value, the wealth equivalence measure suggests that everyone gains from purchasing annuities. And Blacks actually benefit more from annuities than whites, despite having a lower life expectancy, because their lifespans are more uncertain.