Which would you rather buy: An annuity or guaranteed income for life?
Sure they’re the same thing, but not in the minds of many Americans. Annuities have long had an identity problem, with many people having a negative perception of the term itself, thinking an annuity is an overly expensive and complicated financial product.
Despite the advantages that annuities can offer to many prospective and current retirees, they remain relatively unpopular. Researchers at Morningstar wondered whether some of the barriers to purchasing annuities are psychological. To pursue this curiosity, Morningstar conducted an experiment in which they manipulated the label of this insurance product and whether the problem that it’s trying to solve—running out of money in retirement—is on one’s mind.
A total of 1,067 American adults ages 30 and over participated in this study (the median age was 49), dubbed the Annuities Experiment. The full study can be downloaded here.
Morningstar manipulated the frame of the product by labeling it as either an “annuity” or a “guaranteed stream of income,” per random assignment, in a set of questions assessing willingness to purchase the product, comfort with an employer purchasing the product using one’s retirement funds, the portion of retirement savings one would be willing to exchange for the product, and preference for an immediate over a deferred product. As an example, the question used to assess willingness to buy the product was:
I would exchange a portion of my 401(k) balance for [a guaranteed stream of income or an annuity] that starts at retirement and ends at death.
The study participants were (slightly) more willing to exchange a portion of their retirement savings when the product was called a “guaranteed income stream” than when it was called an “annuity.” The variance was about 2%.
But researchers said it shows that a guaranteed income appeals to people. That is, labeling an annuity by its intended purpose, a guaranteed income stream, can give people incentive to purchase the product as part of their retirement preparation.
A second key finding of the study was that thinking about running out of money during retirement increases preferences for deferred over immediate annuities.
Study participants generally desired immediate over deferred annuities. “Approximately 78% of our participants preferred to pay $100,000 for lifelong cash payments immediately at retirement than to pay $29,000 for lifelong cash payments that begin at age 80. Still, participants who thought about the possibility of running out of money during retirement were 8.6% more likely to prefer a deferred annuity,” a Morningstar commentary about the study notes.
“What this finding teaches us is that people tend to want cash now, and they are willing to offer a hefty lump sum for it. Yet, this preference for immediate payments may be grounded in shorter-term thinking, given that eliciting some longer-term planning (that is, all the way to age 80) shifts one’s financial focus from the now to the later; people may be more willing to wait for money if their patience translates into security at a later age.”