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The Costs of Annuitizing Retirement Payouts from Individual Accounts

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  • James M. Poterba
  • Mark J. Warshawsky

Abstract

This paper presents new evidence on the costs of purchasing private annuity contracts to spread a given stock of assets over an uncertain future lifetime. It also describes the operation of individual annuity arrangements within two large group retirement saving plans. First presents information on life annuity contracts that are now available in the individual single-premium-immediate annuity marketplace. For a 65-year-old male annuity buyer present discounted value of the payouts offered by the average policy available in June 1998 was approximately 85 percent of the purchase price. This assumes that the individual faces the mortality risks of the average individual in the population, and that the payouts are discounted at a riskless interest rate. The expected present value of payouts rises if we assume that the buyer faces the mortality rates of the typical annuitant, while it declines if we assume a higher riskier, interest rate for discounting. Second, the paper considers individual annuity policies available to participants in the government's Thrift Savings Plan. Because these annuities are purchased through a large group retirement saving program, some of the administrative costs are lower than those in the national individual annuity market. The expected present value of payouts is correspondingly higher than that in the public' market. Third individual annuity products offered by TIAA-CREF, the retirement system for college and university employees. TIAA offers annuities with non-guaranteed elements the highest payouts in the individual annuity market, mainly due to superior investment returns and low expenses. CREF annuities offer valuable payouts that reflect basis, the investment experience of the accounts.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6918.

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Date of creation: Jan 1999
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Publication status: published as Shoven, J. (ed.) Administrative Costs and Social Security Privatization. Chicago: University of Chicago Press, 2000.
Handle: RePEc:nbr:nberwo:6918

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References

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  1. Benjamin M. Friedman & Mark Warshawsky, 1988. "Annuity Prices and Saving Behavior in the United States," NBER Chapters, in: Pensions in the U.S. Economy, pages 53-84 National Bureau of Economic Research, Inc.
  2. Benjamin M. Friedman & Mark Warshawsky, 1985. "The Cost of Annuities: Implications for Saving Behavior and Bequests," NBER Working Papers 1682, National Bureau of Economic Research, Inc.
  3. Benjamin M. Friedman & Mark Warshawsky, 1985. "Annuity Prices and Saving Behavior in the United States," NBER Working Papers 1683, National Bureau of Economic Research, Inc.
  4. Olivia S. Mitchell, 1999. "New Evidence on the Money's Worth of Individual Annuities," American Economic Review, American Economic Association, vol. 89(5), pages 1299-1318, December.
  5. Gramlich, Edward M, 1996. "Different Approaches for Dealing with Social Security," American Economic Review, American Economic Association, vol. 86(2), pages 358-62, May.
  6. Zvi Bodie & John B. Shoven & David A. Wise, 1988. "Pensions in the U.S. Economy," NBER Books, National Bureau of Economic Research, Inc, number bodi88-1, octubre-d.
  7. Friedman, Benjamin M & Warshawsky, Mark J, 1990. "The Cost of Annuities: Implications for Saving Behavior and Bequests," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 135-54, February.
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Cited by:
  1. James, Estelle & Vittas, Dimitri, 2000. "Annuity markets in comparative perspective : do consumers get their money's wotrth?," Policy Research Working Paper Series 2493, The World Bank.
  2. Peter Diamond, 1999. "Administrative Costs and Equilibrium Charges with Individual Accounts," NBER Working Papers 7050, National Bureau of Economic Research, Inc.
  3. Dean Baker, 2006. "The Conservative Nanny State," CEPR Books, Center for Economic and Policy Research (CEPR), number 2006-01.
  4. Alberto Chong & Florencio Lopez-de-Silanes, 2007. "Corporate Governance in Latin America," Research Department Publications 4494, Inter-American Development Bank, Research Department.
  5. Alberto Chong & Florencio Lopez-de-Silanes, 2007. "Gobierno Corporativo en América Latina," Research Department Publications 4495, Inter-American Development Bank, Research Department.
  6. Olivia S. Mitchell, 2001. "Developments in Decumulation: The Role of Annuity Products in Financing Retirement," NBER Working Papers 8567, National Bureau of Economic Research, Inc.
  7. Amy Finkelstein & James Poterba, 2002. "Selection Effects in the United Kingdom Individual Annuities Market," Economic Journal, Royal Economic Society, vol. 112(476), pages 28-50, January.
  8. Amy Finkelstein & James Poterba, 2000. "Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market," NBER Working Papers 8045, National Bureau of Economic Research, Inc.
  9. Jeffrey R. Brown & Olivia S. Mitchell & James M. Poterba, 2000. "Mortality Risk, Inflation Risk, and Annuity Products," NBER Working Papers 7812, National Bureau of Economic Research, Inc.
  10. Knox, David, 2000. "The Australian annuity market," Policy Research Working Paper Series 2495, The World Bank.
  11. Amy Finkelstein & James Poterba, 1999. "Selection Effects in the Market for Individual Annuities: New Evidence from the United Kingdom," NBER Working Papers 7168, National Bureau of Economic Research, Inc.
  12. Jeffrey Wenger & Christian E. Weller, 2008. "The Interplay between Labor and Financial Markets: What are the Implications for Defined Contribution Accounts?," Working Papers wp162, Political Economy Research Institute, University of Massachusetts at Amherst.
  13. Jeffrey R. Brown & Olivia S. Mitchell & James M. Poterba, 1999. "The Role of Real Annuities and Indexed Bonds in an Individual Accounts Retirement Program," NBER Working Papers 7005, National Bureau of Economic Research, Inc.
  14. Jeffrey R. Brown & Mark J. Warshawsky, 2001. "Longevity-Insured Retirement Distributions from Pension Plans: Market and Regulatory Issues," NBER Working Papers 8064, National Bureau of Economic Research, Inc.

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