Opinion

Are annuities the high-speed rail of retirement plans?

The government has decided to build an 11-mile section of high-speed rail in western New York somewhere between Rochester and Buffalo. There aren’t many passenger trains that go that route and there are no local stops anywhere along that line.

It’s a piece of engineering a few people want and even fewer people will ever use. It’s the classic definition of doing something because we can, not because we need to, of taxing the many for the benefit of the few.

Likewise, the much-aligned annuity is a solution in search of a problem. While politicians, the press and academia have long touted its goodness, industry pros, plan sponsors and even investors have avoided annuities like the plague (see “Why 401k Plan Sponsors and Investors Lack Cupidity for the Annuity,”).

So perplexing is this puzzle, the famous behavioral research tandem of Shlomo Bernartzi and Richard Thaler, together with Alessandro Previtero, tried to tackle this issue in a paper titled “Annuitization Puzzles” (Journal of Economic Perspectives, Fall 2011). 

Of course, you must suspend your disbelief for a moment when you discover the paper was published under the auspices of the Center for Behavioral Finance, an organization sponsored by an insurance company and that Thaler actually works for an investment advisor affiliate of that company. In fact, the paper is fairly reported, as we’ll allude to in a moment.

First, let’s go back in time a few years to the nadir of the Bush-Obama Great Recession. At the low point of the BOG Recession, many declared the 401(k) a failed experiment. With the stock market sickeningly down, far too many workers saw their retirement savings evaporate in a crisis of credit.

They longed for the days of yore, when a patrician company would promises to pay them for not working in their older years. Cries for the return of pension plans, long made extinct by the meteoric rise of the 401(k) during the MesoDisco Era of the early 1980s, rang throughout the land. 

Or so we were told. In reality, the siren call of annuities – the closest thing to a pension plan many will ever be able to get – fell on deaf ears. This inaction inspired Bernartzi et al.

It also inspired the IRS, who, a couple weeks ago, came forth to pronounce their solution to this annuity “problem.” Promoting the “longevity annuity” as only an insurance industry brochure could, the IRS claimed it was the best way to remove income uncertainty during the retirement years and satisfy America’s “desire” for a fixed income.

Oddly, this government agency ignored the investing public’s problem with annuities and couldn’t really answer the question related to plan sponsor’s greatest problem with annuities. 

The IRS proposal doesn’t solve the problem of the lack of retirement savings. The IRS couldn’t answer the plan sponsor liability questions. Does the investor take on the liability? Does the plan sponsor assume it? If the plan sponsor or insurance company goes bankrupt, does the PBGC assume the payments?

The IRS couldn’t answer (although subsequent commentators suggested state insurance authorities would step in).

And we haven’t even broached the subject of fees. 

Of course, our dear professors may be making the same mistake as the others when they refer to the lack of enthusiasm for annuities as a puzzle. It might not be a puzzle at all. You see, the academic puzzle stems from the mathematics of utility theory.

Utility attempts to assign a numerical value to decision nodes. These numerical values often get translated as dollars and sense. This is what the authors of “Annuitization Puzzles” assume.

About the Author
Chris Carosa

Chris Carosa

Christopher Carosa, CTFA, is chief contributing editor for FiduciaryNews.com, a leading provider of essential news and information, blunt commentary and practical examples for ERISA/401(k) fiduciaries, individual trustees and professional fiduciaries. With three decades of experience in the investment industry, Carosa has helped create or found a number of financial products and firms including mutual funds, common trust funds, registered investment advisers as well as a billion-dollar trust company. He is also the author of the new book, "401(k) Fiduciary Solutions." Follow Fiduciary News on Twitter and LinkedIn.

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