Annuities: Useful but Little Understood

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What makes a man tick

The general public is very cool on annuities. But many economists like the idea of retirees using some portion of their savings to buy them.

Annuities, with their fixed monthly payments, may be the best way to ensure retirees’ savings last just as long as they do. Otherwise, they may either spend it too fast and deplete their savings prematurely or spend too conservatively, depriving themselves of necessities in their old age.

New research suggests that one reason retirees don’t buy annuities is because they have great difficulty figuring out what they’re worth. When they try to figure this out, they bump up against their own cognitive limitations – limitations that only worsen with age.

In the study, 2,210 adults over age 18 were asked to estimate the value of a monthly annuity familiar to most workers: Social Security benefits. First, the research subjects were asked if they would pay $20,000 to “buy” a $100 increase in their monthly Social Security benefits. If the person said no, the survey repeated the question with a lower amount, eventually zeroing in on what this additional $100 benefit was worth to them. Next, the research subjects were asked to reduce – or “sell” – their monthly benefits by $100 in return for a specific dollar amount paid to them upfront.

In theory, the buy and sell prices they finally arrived at should be equal. But there was an enormous gap between the two. The median price research subjects were willing to pay was $3,000, and the median price at which they would sell was $13,750. There was also a wide range of sales prices among the individual participants: some would accept $1,500 or less, while others wanted $200,000 or more.

The researchers then showed that the gaps between buy and sell prices – a measure of one’s ability to assess the value of an annuity – were much larger for people with limited cognitive skills and less education. The gaps for people over age 65 were also much larger than the gaps for younger people, reflecting the cognitive decline that occurs with age.

The study confirms that annuities are difficult to value. Most people will buy them only if they’re “an exceptionally good deal,” the study finds, and this impediment to annuitization “is strongest among the least cognitively able.”

The research reported herein was performed pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Financial Literacy Research Consortium. The opinions and conclusions expressed are solely those of the author(s) and do not represent the opinions or policy of SSA or any agency of the federal government. Neither the United States Government nor any agency thereof, nor any of their employees, makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of the contents of this report. Reference herein to any specific commercial product, process or service by trade name, trademark, manufacturer, or otherwise does not necessarily constitute or imply endorsement, recommendation or favoring by the United States Government or any agency thereof.

Tom Anello

It wasn’t so much understanding a straight annuity. It was the the 5-10 options being added in and – of course – at a hefty commission fee!

Mark Zoril

Interesting post. I have worked with many pre- and post-retirees and discussed how they can use annuities (I am a flat-fee adviser and do not sell them, but encourage my clients to understand them and how they can help them in retirement).

However, the biggest hurdle that I have come across is that most retirees don’t like the feeling of losing control over their money. They have a sense that they are giving their money away, even though they are clearly receiving security.

Another factor is that they might distrust the financial services firms offering annuities. Turning over a large portion of your money to any organization, regardless of the quality of the ratings, can be a scary proposition. They may not be confident of what will really happen in the next 20 to 30 years.

Dick Purcell

This problem is greatly amplified by the conflict-of-interest in investment advisors’ AUM-based fees. For the retirement-planning client, the primary measure of best interest is the best future income stream. But for the AUM-based-fee advisor, his own best interest is clients having the biggest current wealth.


Where does one go to get unbiased objective assistance when needed?


I question the validity and limited scope of your research! You cannot make the generalized statements that you have done about “retirees.” You should be more specific with your “sample” vs. your population. A very basic premise in statistical analysis!

Seems like your actually measuring “numerical reasoning” and not necessarily annuity knowledge. I would tend to hypothesize that a group 15 years younger would show the same results in regards to annuity products.

I would like to see you duplicate the study with a lower age group instead of retirees. Also with a group of annuity salesmen whom I have found to know less than they talk about knowing when it comes to actual calculations like asked in your study.

I asked one salesperson what the formula was for a calculation that determined a fee that I had to pay, he did not know, told me to contact the company. When he could not answer, I did not buy! So just do a simple study with the salespeople!!


Isn’t this study kind of flawed? Seems like it’s the price of a U.S. default on Social Security that is hard to value, not the annuity itself.

My point is that participants were asked to value more than a simple annuity. They’re being asked to value an annuity that may or may not get changed by future legislation.

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